I’ve already written at length about the pros and cons of a 15-year fixed mortgage, but some financial experts claim you shouldn’t even buy a home if you can’t afford this shorter-term mortgage option.
You know, guys like Dave Ramsey, and perhaps more reasonable folks like that financial planner you visited recently.
The problem is that many, many Americans simply can’t afford the higher monthly payments tied to a 15-year fixed mortgage, for better or worse.
And that shouldn’t necessarily stop them from purchasing a home.
This isn’t dissimilar to buying a home with less than 20% down if it means getting in the door several years earlier.
15-Year Mortgage or Bust?
- Some financial gurus argue if you can’t afford the 15-year fixed mortgage payment
- You’re buying too much home or simply shouldn’t be buying at all
- But this “rule” is simply too rigid for my liking and could set you back in the long run
- You can always pay more each month, refinance if rates improve, or put your cash to use elsewhere
Let’s talk about the rationale behind this theory first to see why it’s often suggested.
With a 15-year fixed mortgage, you own your home in, you guessed it, half the time.
Just a decade and a half versus the lengthy three decades it takes to pay off a more common 30-year fixed-rate mortgage.
That’s the first big benefit, obviously. Another is you save an absolute ton on interest because the amortization period is cut in half (and the mortgage rate on a 15-year fixed is lower as well).
Taken together, you can save a staggering amount of money simply by going with a 15-year fixed instead of the more commonplace 30-year fixed.
Aside from saving a boatload of cash, you also own more of your home a lot faster.
So if you need/want to move out at some point in the near future, you can probably do so with the 15-year mortgage in place.
With the 30-year, you might not accrue enough equity to afford a move-up home, or simply another home in a similar price range.
Because principal paydown takes such a long time on a 30-year loan, you might not have enough equity to sell if you only hold for a few years.
Conversely, a 15-year fixed whittles down that outstanding balance quickly, making it easier to absorb the fees associated with selling a home.
The 15-Year Fixed Gets Paid Down a Lot Faster, But Costs a Lot More
|$300,000 Loan Amount
|Monthly P&I Payment
|Total Interest Paid
|Remaining Balance After 60 Months
Let’s look at an example between a 15-year and 30-year payment. As noted, the mortgage rate is typically discounted on the shorter-term loan.
This is a perk for the homeowner since the lender is taking less risk. If they extend a fixed rate for a full 30 years, they need to bake in some profit and offer a slightly higher rate.
After five years of on-time mortgage payments, our hypothetical $300,000 mortgage balance is only paid down to around $282,000 if it’s a 30-year loan.
Meanwhile, during that same span the 15-year fixed is left with a balance of just over $229,000.
A homeowner who maybe wisely opted for the 15-year fixed would have over $70,000 in home equity (not to mention any home price appreciation during that time).
That could be plenty for a down payment to move up to a larger home.
The 30-year fixed buyer would have less than $20,000 to play with…factor in costs to sell the home and it might not be enough to buy a replacement home.
Oh, and the 15-year fixed borrower would save nearly $250,000 over the life of the loan thanks to a much lower interest expense.
It’s for these reasons that financial gurus will tell borrowers to go 15-year fixed or bust.
The argument is essentially that the 30-year fixed mortgage is a bad deal for homeowners and should be avoided at all costs.
There’s a Reason the 30-Year Mortgage Exists
- Blanket rules are hard because home prices vary considerably by region
- In some areas they’re far too expensive for most home buyers to pay them off in 15 years
- You can also argue that paying off your mortgage isn’t always the best investment
- Especially when mortgage rates are at or near historic lows
As you can see, the savings associated with a 15-year fixed are tremendous.
The problem is most home buyers probably can’t afford one. You can blame high home prices for that.
Sure, in areas of the country where homes regularly sell for $150,000 it might not be a big deal.
The difference in monthly payment could only be a couple hundred bucks.
But in areas where homes sell for much, much more, we’re talking a night and day difference in monthly payment.
The mortgage payment on the 15-year fixed from our example above is around $600 higher, even when factoring in a lower mortgage rate.
Many individuals barely qualify for the mortgages they take out, and that’s with the much lower 30-year fixed payment. Adding another $500+ in monthly outlay probably won’t fly for most.
Does this mean they shouldn’t own homes? Absolutely not. It just means the bank will own most of your home for a lot longer. And that you won’t be as heavily invested in your property.
While it sounds great on paper to throw everything toward the mortgage, a lot can go wrong when you’re in too deep on one investment.
Remember the old “all your eggs in one basket” idiom?
Shouldn’t these same financial gurus be wary of that as well, especially if home equity makes up the overwhelming majority of your personal wealth?
The Strategy Can Backfire Despite Sounding Conservative
- If you pay off your mortgage in 15 years you might have all your money locked up in your home
- Whereas the 30-year fixed borrower will have cash for other expenses and investments
- One could argue that a longer-term mortgage enhances diversification
- It allows a homeowner to invest elsewhere and have a more well-rounded portfolio
We all saw what happened a decade ago when the housing market collapsed.
I assume those who made 15-year fixed mortgage payments weren’t too happy that their property values were sliced in half.
The 30-year fixed mortgage folks probably weren’t thrilled either, but at least they could cut their losses or continue to make smaller payments as they assessed the rather dismal situation.
Even in good times, you can get pretty house poor making massive mortgage payments each month if they’re barely affordable. Throw in a job loss and it can get scary fast.
And you may neglect other, arguably more important investments such as a retirement account or college fund, along with other higher-interest debt.
When it comes down to it, you always have the option to make a larger payment (or extra payments) on a 30-year mortgage.
It’s also possible to refinance into a shorter-term mortgage once you’re in a better position financially, perhaps once you’re a bit older or close to retirement.
Start with a 30-Year Mortgage, Consider a 15-Year Loan Later
One way to get the best of both worlds is to start out with a 30-year fixed mortgage then refinance into a 15-year loan if makes sense to do so.
This could work for someone sick of renting, which these financial experts probably also advise against, who can’t quite afford the larger payments today.
It at least gets them in the door, literally, so they can begin building wealth through home equity.
At the same time, it’s also perfectly acceptable to just stick with a 30-year fixed the whole way because it’s often a very cheap debt.
There are lots of savvy individuals who recommend putting your extra cash somewhere other than the mortgage, such as in the stock market, retirement account, etc.
That’s not to say a 15-year fixed won’t save you a ton of money, or that it’s perhaps a cool rule of thumb when setting out to buy a home.
In a perfect world, it’d be great if we could all afford the 15-year fixed mortgage payment. But that’s just not today’s housing market.
Of course, results will vary based on where in the country you intend to buy. And how much you make. But don’t be discouraged or feel you can’t take part based on mortgage product alone.