Short Term vs. Long Term |
Fifteen-year mortgages are becoming increasingly popular among homebuyers who want to get rid of the debt in less time and save a bundle in interest expenses.
With a 15-year mortgage, the interest rate is typically lower and the payments are higher than they are with a 30-year mortgage.
But even if you can afford the higher payments, you should consider the alternatives.
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You might wind up ahead of the game by taking out a longer-term loan. Lower payments and tax benefits could save you money if you have the discipline to invest the money rather than put it into house payments. |
The "savings" comes from the money you have in your pocket, each month, by paying off the mortgage over 30, rather than 15 years. The difference is what you should invest.
For example, let's say you take out a 30-year mortgage at 7.25 percent interest. Assuming a 40 percent combined federal and state tax bill, your after-tax cost of borrowing is only 4.35 percent (7.25 percent times 60 percent).
If you invest the monthly savings in stocks and earn more than 4.35 percent a year after taxes, your longer-term mortgage already is paying off. Consider these two scenarios:
1. You take out a 30-year mortgage, and for the first 15 years, you regularly invest the after-tax savings in stocks or mutual funds.
2. You take out a 15-year mortgage for the same amount. After the mortgage is paid off, you invest an amount equal to the after-tax cost of the 30-year loan each month.
Which is better? The first scenario, if the pre-tax return on your investments is more than six percent. That's not unrealistic since the average long-term growth rate of stocks is 10 percent.
And the savings would be even greater if you put the extra money in a 401(k) plan or IRA because of tax breaks available on retirement accounts.
Take your time before jumping into a shorter-term mortgage. You could wind up with more money for your retirement years.
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