With interest rates still near 40-year lows, is a 30- year, fixed-rate mortgage the right choice? While the mass media's response is usually yes, my reply is NO.
Today's market is much different than the market and lifestyle of the previous generation. That generation typically had one job, one pension, one house and one mortgage. That lifestyle no longer holds true today. Pension plans seem to be a thing of the past unless you are employed in the airline industry and many of the public services agencies. Most Americans will hold five or more jobs throughout their careers. As far as houses and mortgages, the average family remains in a house for only seven years and the average mortgage lasts only four years.
Even if you found your dream house and never plan on moving, a 30-year, fixed-rate mortgage may still not make sense for you. Here are some common questions to ask yourself before you choose any mortgage product.
1. Do you have (or plan to have) children? If yes, do you think that you will have to pay for a college education and/or a wedding?
2. Over the next 30 years do you think that you might lose your job and incur some debt as a result of a job loss?
3. Do you have elderly parents that might require long-term health care needs?
4. Maybe you will want to do some home improvements such as an addition or an upgrade to your kitchen?
If you answered yes to most or all of these questions, a 30-year, fixed-rate mortgage may not be the right choice for you. All of those reasons trigger the "need" to refinance and the "interest rate" is not the driving force. Of course you want the best rate at that time, but no matter where rates are you need to refinance.
When people decide to refinance, only a small percentage of them refinance due to lower interest rates. My experience has been that most people refinance for other reasons as suggested above. By choosing an Adjustable Rate Mortgage (ARM) instead of a 30 or even a 15-year, fixed-rate mortgage, you can save hundreds of dollars a month which will equate to thousands of dollars over a couple of years. Also, keep in mind that 15 years into a 30 year fixed rate mortgage you still have 71% of the outstanding balance remaining.
By choosing a mortgage other than a traditional 30 year fixed rate mortgage you can free up money on a monthly basis. This will give you the ability to pay down those credit cards; re-direct the savings into a college fund or your retirement fund and/or create the ability to purchase a second home.
Then there is the icing on the cake regarding tax planning. When you have a typical amortizing mortgage (30 year fixed) you are paying both interest and principal payments each month. Each month you make your mortgage payment, the amount directed towards the interest decreases. While this may sound like good thing it may actually be bad. The analogy I like to use is "it is like driving through life with one foot on the gas and the other foot on the brake". What I mean is each year you earn more money (foot on the gas) while your tax deduction is getting reduced (the brake) with each and every mortgage payment. Your earnings are increasing and your deductions are decreasing; you're killing your best partner Uncle Sam in the way of income tax deductions. With an interest only mortgage, the mortgage interest deduction on your returns will remain constant for a certain number of years. This gives you the ability to keep more of your earnings and not pay them to Uncle Sam.
Unlike the lack of choices afforded to the prior generation, there are literally hundreds of different mortgage products available. Choosing a mortgage today is much more complicated than "what is the interest rate"? When you are deciding on what type of mortgage is right for you make sure that your Mortgage Planner is versed in all of these areas. They should not simply be an order taker.
A good Mortgage Planner should take the time to meet with you personally to investigate what the best option for YOU might be. Again, you might be thinking "it's only a mortgage" but remember for most people a mortgage is the largest financial decision they will ever make. Don't make that type of decision in a couple of minutes over the phone. Your financial well being depends on it. Take the time to research the products out there and sit down with a Mortgage Planner to ensure he/she is knowledgeable on all products and is interested in you as a client and not just taking your order.