You’ve found the home or your about to get started with your search but you are in the “crunching the numbers” phase and the question arises, should we pick a 15 or 30 year fixed mortgage? Well, there’s a lot to consider…not only is buying a home a big step but deciding the terms of your contract is where you will have to put your money in play. There are strong financial differences between a 15 and 30 year mortgage. So, let’s crunch the numbers and then talk about the 6 points I want you to consider before you make your long term commitment.
From this info graph, you can see that the only con with a 15 year fixed rate mortgage are the larger monthly payments. Keep in mind that the monthly payments only consider principal and interest. There are 4 pieces to a mortgage payment and this does not consider the property taxes and home owner’s insurance. In addition, if you put down less than 20% you’ll have to add private mortgage insurance (PMI) on top of that.
Even though the 15 year mortgage will save you thousands of dollars in the loans lifetime versus a 30 year, home owners in America prefer the 30 year mortgage. According to Freddie Mac, 90% of the mortgage market is dominated by the 30 year fixed rate mortgage! There’s a good reason for this and it has to do with the following:
You need to ask yourself can you afford the payments for the 15 or 30 year mortgage. To set a safe benchmark for your affordability analysis, make sure that your mortgage payments do not exceed 30% of net income. Take a look at one of my previous posts about this subject.
Use an amortization calculator to estimate how much interest you will be paying. Make sure to compare the 2 mortgage terms and ask yourself whether you are willing to pay all of that extra cash for the home. Your lender should be able to provide this analysis for you as well.
3. Cash flow
This is tied in with affordability, but you should consider how the future mortgage will impact your cash flow. If you accept the terms of the mortgage, are you spreading your cash too thin? Will you have to change your lifestyle? Will you need to cut expenses or reduce your budget in other areas?
On the other hand of cash flow, if your household income increases then more power to you! Now you can dedicate more cash to the payments of your mortgage principal. The extra payments are crucial because you will reduce the overall interest that you pay, gain more equity in your home which can help you refinance (if needed), and reduce the life time of the loan!
4. Renting your home
What if you got offered a new job in a different city/state or something in your life is requiring you to move? You should consider the historical market value of rentals in your neighborhood and the current rental prices. If the rents have been and are below the 15 year mortgage monthly payment, then you may want to consider the 30 year mortgage. The point here is that if you ever need to rent your home, you want your renters’ monthly payment to cover the mortgage (at a minimum) so that you don’t experience negative cash flow.
5. Emergency Fund
This is a big one to consider because homeowners have more costs compared to a renter and having a home means unexpected expenses, like an AC or roof repair . I cannot stress enough that you need to have at minimum 3-6 months of living costs in a high yield savings account. So, does your emergency fund cover your living costs, including the new home you’re about to acquire? If you don’t have this emergency fund, you may want to consider the pros and cons of being a renter and a homeowner.
6. Will this affect your retirement contributions?
As you analyze your impact to cash flow and affordability, you don’t want this to affect your ability to contribute to your retirement. As a benchmark, you should contribute 10% – 15% to retirement. Retirement contributions are important because the last thing you want to do is rely on Social Security…who knows if that will even exist by the time you retire.
The bottom line is to consider all aspects of your financial life and the pros and cons of the 15 and 30 year fixed rate mortgages. Once you’ve signed on the dotted line you are 100% committed to the new mortgage payments.
You could always refinance, but that’s a separate conversation and another blog post.