March 8th, 2017 5:37 AM by Jackie A. Graves, President
You're all ready to buy your new home! You've
found an affordable home or two that you really like. You've saved up a bundle
of money for your down payment. You've built up a strong credit score so that
you can get offered low interest
rates Opens a
New Window.from lenders. Maybe you've even been pre-approved Opens a New Window.for your mortgage. What's next?
Well, you need to
decide exactly what kind of mortgage you should take on. It's a big decision,
because home loans last for many years and are probably the most costly
expenses you'll ever take on. Take the time to learn all about your options.
One critical choice is deciding between a 30-year mortgage and a 15-year one.
Most mortgages that
home buyers take on are either 30-year or 15-year ones, with 30-year fixed-rate
loans being the most common by far. Here's a closer look at both.
The main advantage of the 30-year mortgage over a 15-year one is
that it features much lower monthly payments. Here are some simplified examples
using a constant interest rate:
The same table reveals a related benefit of a 30-year loan: It
lets you buy more home for your money. For example, you might pay about $1,200
per month for a $200,000 house with a 15-year loan, but that same payment on a
30-year loan gets you a $300,000 home.
payments also leave you with more money in your pocket -- or they can, if you
haven't taken on too much risk Opens a New Window.by
buying more home than you can safely afford. More money in your pocket means
more money that you can sock away in critical retirement savings accounts or
more money for your college savings account or money for an emergency fund.
(Emergency funds are particularly important if you're carrying a mortgage, as
you don't want some sudden unexpected expenses to leave you unable to make your
mortgage payments and at risk of losing your home.)
Another perk of a fixed-rate 30-year loan is that thanks to
inflation, your fixed monthly payment will cost you less and less as the years
go by. Yes, it may stay at $1,200 per month for 30 years, but after 25 years,
if inflation has been at its long-term average of about 3% annually, it will be
like paying just $573 per month. That's because incomes and prices will have
risen over the years. So while $1,200 might have been 25% of your monthly pay
25 years ago, it might only be 15% of your monthly pay years later.
rates for 15-year fixed-rate loans tend to be about half a percentage point to
a full percentage point lowerthan those for 30-year loans. That means you'll
pay less in interest. You'll actually pay far less in interest over the life of the
loan, simply because you'll be making payments for half as many years. Consider
this example froma Bankrate.com calculator: Imagine you took out a $200,000
mortgage at the recent national averageinterest rates of 4.27% for a 30-year
fixed-rate loan and 3.49% for a 15-year fixed-rate loan. You'd pay a total of
$57,181 in interest over the life of the 15-year loan and $155,040 over the
life of the 30-year loan. That's almost $100,000 more!
A 15-year loan will help you build equity faster, as you'll be
paying less in interest. It's always good to have equity in a home, as that's
the value you can hope to recoup when you sell, and it's the value that counts
if you need to take out a home equity loan in the future.
If you're older, a 15-year loan can be preferable as you'll be
more able to pay off your home before you enter retirement. Being mortgage-free
in retirement can help you sleep better at night.
So what's the right choice for you? Well, if you know you can
afford the payments for a 15-year loan now and in the future, that option will
save you the most money. It's also best if you're approaching retirement. If
you're younger, though, with more financial uncertainty in your life -- and
other pressing financial needs and goals -- opt for the 30-year mortgage.
Don't stop there, though. Make sure the loan you take on permits
extra prepayments. If it does, you can aim to make bigger monthly payments than
what's required. If you pay, say, $1,800 per month instead of the $1,200, you
can shave many years off the life of your loan and pay tens of thousands of
dollars less in interest. Best of all, if you're financially pinched for a few
years, you can just revert to paying the $1,200 per month until you're back on
your feet. This strategy offers the best of both worlds.
Consider an adjustable-rate mortgage (ARM), too -- but only if
you're not expecting to be in the home for many years. An ARM will typically
charge you a very low rate for the first three, five, or seven years, before
starting to be adjusted annually according to prevailing rates. (As interest
rates are expected to rise in the years ahead, an ARM is rather risky for a
long-term tenure.) If you think you'll be in the home for decades, it's
probably best to lock in a low rate for the entire long life of the loan.
The more you know about mortgages, the more home you can get for
your money, and/or the less money you can spend on interest. Be a savvy home
buyer and you can probably save tens of thousands of dollars.
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