Financial planners and other prudent financial “types” have long held a grudge against the 30-year mortgage, and with good reason. The (now) standard 30-year mortgage term has cost Americans, on the whole, unfathomable sums of money since they became, well, standard. Banks have historically loved the longer-term mortgages because they ultimately put far more money into their pockets, and financial advisors have despised them for that same, exact reason.
Now, the very survival of the 30-year mortgage mechanism is at risk, thanks to the economic upheaval that we’ve all come to know so well. Beyond the tightening of underwriting standards overall, Fannie Mae and Freddie Mac, the “government-sponsored entities” that have gone such a long way to fueling the American Dream of home ownership through their mission of implicitly guaranteeing mortgages and thus keeping them cheap and easier to obtain, are faced with the very real prospect of seeing themselves drastically reduced or even eliminated outright. Should that happen, the cost of the mortgages would likely rise, and jeopardizing the only real benefit that mortgage term offers: the lowest payment available, in general.
This is good news, truthfully. Although I believe the 30-year mortgage will remain among us in some form or fashion, as even without any government backing, the free market will keep it available for those who can pass the new, more stringent underwriting standards that will accompany it, the point is that it has always been a bad deal. It has led people to pay far, far more for their houses than they should, and demands that homeowners wait years to build up any real equity because of how slowly the loan amortizes.
Here’s a quick example. If you buy a $200,000 house with a 30-year mortgage at 5.5% fixed, the monthly payment (principal and interest) is $1,135. If you buy the same house with a 15-year fixed mortgage that’s priced at 4.5% (the interest rates on 15-year mortgages are often about a point less than those on 30-years), the monthly payment is $1,529. Higher, for sure, but nowhere near double that of $1,135. In fact, it’s about $400 per month more. In exchange for agreeing to a monthly payment of $1,529 instead of $1,135, the buyer could own the home outright in half the time, and pay a lot less for the privilege. How much less? The $200,000 home, financed for 30 years at the terms noted above, will ultimately cost a grand total of $408,000 when it’s all said and done. The same $200,000 home financed for 15 years at the terms noted will ultimately cost the buyer $275,000. So, for an unwillingness to find a way to come up with another $400 per month, the 30-year buyer…the “standard” buyer…will pay an additional $133,000 for the same house over what the 15-year buyer pays.
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Bob Yetman, Editor-at-Large at Christian Money.com (www.christianmoney.com), is an author of a variety of materials on personal finance and investing, as well as on topics of fitness and self defense, to include the book Investor's Passport to Hedge Fund Profits (John Wiley & Sons, Inc.) and the unarmed combat training DVD Thunderstrikes - How to Develop One Shot, One Kill Striking Power (Paladin Press).