Many borrowers who want a fixedrate loan should choose years not or

For four decades, the 30-year, fixed-rate mortgage has ranked as the most popular loan product because it permits you to obtain larger amounts than a loan of shorter duration (though many lenders offer 40-year fixed-rate loans, few borrowers choose this product). With this "lower payment" advantage, the 30-year loan pleases most homebuyers and investors. More recently, though, many borrowers have begun to question this longstanding, often automatic choice of loans. Investors have favored adjustable rate mortgages (ARMs) and interest only products to enhance their cash flows. Homebuyers—especially those over age 40—have been choosing 15-year terms.

The High Costs of 30-Year Loans

Historically, not more than one out of five potential borrowers has carefully calculated the costs and benefits of 15-year as opposed to 30-year

1 For purposes here, I'm ignoring the costly practices and loan programs of predatory lenders (see Chapter 8).

Table 3.1 Save with a 15-Year Loan: Interest Costs of

15-Year vs. 30-Year Loans at Currently Available

Interest Rates

15-Year Term

30-Year Term

Mortgage amount

$200,000

$200,000

Interest rate

5.9%

6.5%

Payment frequency

Monthly

Monthly

Monthly payment amount

$1,676.92

$1,264.13

Total interest paid

$101,846.91

$255,088.92

30-year extra cost

$153,242.01

mortgages. In thinking 30 years, borrowers focused on affordability. But they did not calculate their total interest costs and equity build-up.

Total Interest Costs

You will pay an astonishingly higher amount of interest with the 30-year loan relative to a 15-year loan. Your savings on the 15-year plan result from two sources: The 15-year loan can slice .25 percent up to .6 percent off the rate you might get on a 30-year loan, and you pay interest for half as long. Compare the interest costs shown in Table 3.1. These figures show you will pay $153,242 more for the pleasure of taking twice as long to pay off your mortgage—a pretty hefty cost disadvantage.2

(Note: I again emphasize that interest rate spreads for maturity risk (i.e., term of the loan) and default risk (quality of the loan/borrower) fluctuate. No consistent rules of mortgage selection apply. That's why you must compare a variety of loan products and loan terms. The loan/lender that looked best last week, last month, or last year may not still look best at the time you're originating (refinancing) your loan.)

Equity Build-Up

Now, think how your choice of financing will add to (or diminish) your future net worth. Look at Table 3.2. Not including appreciation, the figures

2To calculate and compare precisely, figure in principal reduction and tax deductions. These complexities won't significantly change the results for most borrowers.

Table 3.2 Equity Buildup Due to Mortgage Paydown: 15-Year vs. 30-Year

15-Year Term 30-Year Term

(Balance) (Balance)

Table 3.2 Equity Buildup Due to Mortgage Paydown: 15-Year vs. 30-Year

15-Year Term 30-Year Term

(Balance) (Balance)

Original loan

Total paydown @ 10 years

Total paydown @ 15 years

$200,000 113,048 200,000

($200,000) (86,952) (-0-)

$200,000 30,466 54,898

($200,000) (169,534) (145,102)

show that the 15-year mortgage grows your equity much faster. After 15 years, you've paid off the full $200,000. But with the 30-year loan, after 15 years you still owe a whopping $145,102.

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