Friday, January 21, 2011

Should you get a 15- or 20- year mortgage?

A short-term mortgage can be a good idea, if you budget for it.

In response to my posting "Never Get an Adjustable Rate Mortgage" I received a SPAM posting from a Mortgage Broker in the UK.  SpamBots patrol these blogs and then post "helpful responses" that link back to their commercial sites.  I generally do not post such comments (UPDATE:  This is one reason I have disabled comments).  Often the sites they link to are promoting the exact sort of financial behavior I am criticizing.

The comment from the Mortgage Broker, which was generic enough to make me think it was bot-generated, was:

"One can shorten the length of their mortgage by reducing the term of the loan. Their Monthly payments will go up, but they will be able to save more in interest payments. Moreover, they will be debt free sooner."
While this comment has merit on its surface, it is a good idea to pursue?  The answer is a qualified YES.

If you are willing to buy a smaller or less-expensive home, and thus learn to live with less, then it is possible this may be a good idea.  While the monthly mortgage payments on a 15- or 20- year note might be higher, the corresponding interest rate is usually at least a point lower, so not only do you pay off the mortgage sooner, you pay it off at a lower interest rate.

So what's not to like?  After all, you are paying less interest, paying down debt, and becoming debt-free sooner - all the sort of things I preach (and yea, I preach) in this blog.

The only downside is to make sure you can afford the higher payment.  If you buy a good sized home and then finance it on a 15-year note, and your monthly payment is 1/3 of your income - or more - you might find yourself "financially stressed".

And if you are struggling to make the monthly mortgage payment, you might find it hard to make other payments in your life.  As a result, you may run up credit card debt or other debts, and end up in worse shape than before.

In addition, if you run into some financial difficulty, it may be harder to make that payment and you will really be behind the 8-ball.  Once you are financially distressed, it may be harder to refinance on 30-year terms, and the cost of refinancing will add to the overall loan.

If you can buy a less-expensive home and budget accordingly, or you are refinancing a loan that is already a decade old (and has some principle paid down) I would say "go for it".  But if you are buying a home that is going to be a budget-buster as it is (why are you buying it again?) then trying to go to 15- or 20-year terms might be a disaster.

Mortgage Brokers often offer the helpful advice that "with a 30-year loan, you can always make excess principle payments and pay off the loan sooner!" which brings up two points.

First, realistically, most people say they are going to do this, and never do. There is always something clamoring for that "excess" money, usually a new car.  And of course, the interest rates on 30-year notes are higher than for shorter terms.   A 15- or 20-year mortgage is a forced savings plan like life insurance or payroll deduction, and thus does provide some financial discipline, if you can afford it.

Second, with any mortgage, be sure to ask about pre-payment penalty fees or other "gotcha" clauses. In many States, these are illegal (which is why interest rates vary from State to State - local regulations).  And usually, these sort of "gotcha" fees are tacked on to the worst sort of Mortgages - Pick-A-Pay, ARMs and Toxic ARMS, Liars Loans, etc. 

But be sure to ASK. Because if you end up refinancing or paying off the loan early, you may be liable for thousands and thousands of dollars of interest payments the banks are not receiving.

I never went with a 15- or 20-year loan during my life.  In retrospect, I wished that I had, on occasion, when the opportunity arose.  But rarely did the opportunity arise!  With our first mortgage, it was hard enough make the payments (being young and poor and interest rates at 8.625% or more!) and with subsequent mortgages, particularly for investment properties, such options were not even available.