15 vs. 30 Year Mortgage
Can We Afford 15 Year Mortgage?
My husband and I have an ideal piece of property that is paid off and ready to build on. We have picked an economical plan (one that is cost-effective to build because of it's shape and style) and we have a builder we trust. Despite that, we will still need to take a loan. The monthly payments on a 15 yr. loan are slightly over 40% of my husband's income, but we have always thought a 30 yr. loan would be a mistake.
Right now our rent is only $400 / mo. so we are able to save substantially, but we also realize that a house is an investment, and with two children (boy and girl) who need separate rooms, it will soon be a necessity. We don't want to become house-poor as so many people seem to be, nor do we want to be apartment-bound for many more years. Can anyone offer some insight into this situation? Thank you!
More Than Two Choices
There are three ways to reduce your monthly payments. Extend the term of the loan, reduce the interest rate, or increase the size of your down payment (thus reducing the amount you will borrow).
Since you are able to save a substantial amount each month, you should be able to save up a nice down payment If you wait a few months, your down payment will be that much greater.
One way to reduce your interest rate is to pay points. A point is a fee that mortgage companies charge (in addition to all the other closing fees). The more points you pay, the lower your interest rate is. One point is equal to one percent of your loan.
Be sure to shop around. Different lenders offer different rates and different programs. You may qualify for a first time home buyers program that could reduce your interest rate further.
You could consider a 20 or 25 year loan instead of a 15 year loan. Your options are not limited to 15 and 30 years.
You could also consider a variable rate mortgage. With this type, the interest rate is not set over the life of the loan, but varies after a certain fixed period. The interest rates for variable rate mortgages are usually a lot lower than a fixed rate, but can increase significantly if interest rates go up.
The best advice I could give you is to sit down with a mortgage broker, and discuss all the details of your plan. The mortgage broker will be able to give you more specific information, taking into consideration your income, debts, savings and payment history. They should be able to come up with a plan for you that you all feel comfortable with.
Don't forget to add taxes and insurance to your monthly budget calculations, as well as the various utilities that may be included in your rent. And don't forget about the mortgage closing costs, when considering the amount you will be able to put down. Closing costs could amount to several thousand dollars. Your mortgage broker is required to give you a "good faith" estimate of the closing costs.
Watch Debt to Income Ratio
It may not be a matter of how much mortgage YOU want to take on....as much as how much mortgage the lender will allow you. While lenders are getting more liberal about their ratios, 40% of your income is still pretty high....and if you have any debts (credit cards, car loans, etc) your ratio is even higher than 40%. And when you consider how much you can afford, don't forget to factor in the tax savings you'll get (making your husband's take home pay a little more), but also remember to plan for the inevitable minor repairs you will have to make each month on your own house, those used to be paid for by the landlord! Plus you need to plan to save for the big expenses, like a roof or siding, etc.
Ask the lender for a 30-year mortgage, but make sure that it does not have any prepayment penalties. Then ask your lender to print out a payment scheduled for you based on 15 years (you can also find places on line to do this). Then when you go to write your mortgage check each month pay off of the 15 year schedule, rather than the mortgage bill.
Having a 30-year mortgage and paying it early by using the 15-year schedule has another very important advantage. What if you take on that 15 year mortgage with it's really high payments and something happens making those payments impossible for you to make? This could be a lay off or loss of job, an extended illness, or as happened to my family an auto accident which disabled my husband for the better part of a year with a substantially lowered disability income... or even a major financial setback, like a large car repair bill, or something needing immediate repair on the house (plumbing problems for example). Then you're stuck with a 15 year payment that you can't make and you risk losing your home! But if you actually have a 30 year payment that you're paying ahead, then you can cut back and only pay the minimum due (which is the 30 year rate). Then when and if you can resume the 15 year payments do so, but in the meantime the lender won't be at your door!
If you decide to still go with the 15 year mortgage and find resistance from your lender due to your ratio show them what you have been putting away into savings each month. My sister (who had only recently cleaned up her credit so it was still being used against her) showed the mortgage company that she was putting into a mutual fund the difference between her current rent and the mortgage payment she wanted. In other words, in your case if you mortgage is $900 and you are paying rent of $400, show the bank that each and every month for the last year or so you have been able to put away a minimum of the $500 difference (and keep saving it, not spending). This should show the lender that you are capable of $900 payments, because in essence you were "paying" yourself that $500 extra each month. It won't work with all lenders, but some will take each case individually and see the logic in this scenario.
Twice Monthly Payments
Check with the bank you are financing your loan with. Ours lets us make 2 payments per month. Our mortgage is $950 per month. We pay $475 (or more, depending on if we have extra money that week) every 2 weeks. The extra payment is taken off the principle amount and essentially cuts our mortgage in half. We have a 30 year loan but we will have our house paid off in 7 years if all goes according to plan. My husband and I both get paid every other week, and sadly the same week. This way we are easing the burden of one big payment a month to 2 smaller ones. Works great for us. Some banks may have an early payoff penalty. Be sure to check.
Just One Extra Payment a Year
They can pay off a 30-year mortgage in 15 years if they just add one extra mortgage payment a year. That way, they are not committed to the higher monthly payment, but can still pay their mortgage down faster. Sometimes it's easier to make an extra payment with an income tax refund or something than have to come up with the extra money every month.
Consider Tax Deductions
Since the mortgage companies take their interest first when you are paying off a mortgage (and a very small percentage is going toward the principal), and this interest, or a portion thereof, depending on your income, is deductible when itemizing for the IRS, you should always get a 30 yr. mortgage - if you later want to move up to a larger house, you've enjoyed the lower monthly payments along with the interest deduction on your mortgage, or if you prefer to pay off the mortgage earlier, you can also do that (but make sure there is no early payment penalty). Either way, it's a win-win situation with a 30 yr. mortgage.
Updated September 2013
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