A Mortgage That Feeds Your Piggy Bank
This summer, we finally decided to take the plunge we'd been contemplating for a while: converting our 30-year mortgage to one with a 15-year payoff. It's a big step. Our payments will go up somewhat (the PITI -- principal, interest, tax, and insurance -- will rise by 19 percent), and every financial analyst I know is mentally screaming in anguish at the thought of taking money I could be investing, and pouring it into earlier payoff of a low-interest (low, tax-deductible interest) loan.
Nonetheless, we decided to take the plunge. And since it's the sort of switch that might benefit some users, I thought I'd run through the reasons you might want to consider it:
- If you've built some equity, or had a high interest rate, your payments won't increase that much. Before the refinance, we'd been paying a substantial extra sum on the principal every month. In 3 1/2 years, we'd paid down about a seventh of our mortgage balance. That might not sound like that much, but it meant that with the interest deduction, our payment only increased a few hundred dollars a month. Yet it delivered almost half the benefit of making a whole extra payment every month.
- Your interest rate decreases dramatically. We had a pretty good mortgage rate -- for 2010. But our new rate drops that interest rate by a full point, saving us thousands a year. Oh, sure, we'll lose some of our tax deduction. But we'll still have thousands of extra dollars in our pocket over the long term.
- Over the life of your loan, you'll save 65 percent of your total interest costs. On a 30-year loan at current rates, you'll pay almost $300,000 in interest costs on a $350,000 loan, versus about $100,000 on a 15-year loan. The benefit comes from two things: shortening the payment term, and lowering your interest costs. I don't know about you, but I could find something to do with an extra $200,000.
- Interest rates are going to have to go up sometime soonish. Mortgage rates are not at their all time lows (more's the pity). But they're still very low, and by refinancing now, you can lock in 3 percent or so. As inflation rises, this will ultimately mean that your mortgage loan is practically free. But this state of affairs cannot last forever; the Federal Reserve will eventually be pulling back on credit, and you will not be able to get such a good deal. Why not lock it in now?
- Enjoy the benefit of forced savings. If you're like me, and you get excited by the first of the month because it means you can make your extra mortgage payment and watch the loan balance go down, then maybe you don't need this. But if you'd like to save, but somehow never get around to it, a 15-year mortgage basically pays you to exercise a little more self-discipline.
- Stabilize your housing costs. Obviously, this is a long-term goal. But going into your 50s with the house paid off means that no matter what else happens, you can't lose your house. The average renter spends about 25 percent of their budget on shelter; for the average homeowner with a mortgage, that drops to 20 percent. But for those without a mortgage, that figure is only 11 percent. Knocking almost 10 percent out of your budget makes you much more resilient in the face of job loss or other troubles -- and gives you extra money to pay college tuitions, or take that cruise you've been thinking about.
Of course, a 15-year mortgage isn't for everyone. Here are some reasons you might not want to take one on:
- Your mortgage payment is already stretching your budget. If you have a very high interest rate, refinancing to a 15-year could actually save you money. But most people don't have a 7 percent mortgage any more. So most people are going to see their payment go up. If your mortgage is already at the limit of what you can afford to pay, then you won't be able to swing this.
- You're planning to move in a few years. Mortgages come with fees. You'll earn those back pretty quickly with a lower interest rate, but not instantly. We figure it will take us a little less than three years to recoup our refinancing costs, which included points to buy down our rate. That's fine with us, because we love our house and have no intention of moving. But if you think you'll be moving before you recover your closing costs, then leave well enough alone.
- You're still underwater. If you don't have equity in your house, you probably won't be able to refinance, though you should check with the bank that holds the loan.
- Your credit has gotten worse since you took out your mortgage. A lot of people have had setbacks in the last few years -- job loss, business failures. If you're among them, and your travails have dinged up your credit, then you probably won't get a good deal on your interest rate -- though it can't hurt to check.
- Your income is highly variable, or your industry is unstable. If you're in a troubled business, or region, then you may want to keep your lower payment as insurance. Instead, thinking about paying extra on the mortgage every month. Even a few dollars helps.
One final caveat: You shouldn't think of this as a substitute for other savings, but an addition. You don't want to end up with most of your savings locked up in home equity, which will be hardest to access when you most need it: during a recession. Refinancing to a 15-year should come after you've ensured that you're putting away 15 percent of your income toward retirement, and 5 percent into emergency funds and other savings.
But if you're already saving what you should, consider adding a 15-year mortgage to your savings plan. You have nothing to lose but your mortgage-interest tax deduction.
This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.
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