I love 15-year mortgages, but they stink
In seller’s market, they can put you in tight spot
This is the final of a series where I explore the financial products I love the most but through a highly critical lens. I will not focus on the positives.
The U.S. housing market continues to boom. In my neighborhood, a “for sale” sign appears in a yard one day and, a day later, the “sold” sign gets added. To label it a seller’s market would be quite the understatement.
The frantic nature of listing and selling can leave a buyer feeling tremendous pressure. And, it can leave his or her homebuying budget in shambles. Because of this, the way a person finances a home purchase becomes increasingly important.
A hot housing market dotted with quick-selling homes often means raising your offer to get the winning bid, which makes the 15year mortgage less attractive or affordable. That leaves you with the next best option, the
30-year mortgage. That’s how binary home financing has become. This is mostly because both are better options than the lessused interest-only mortgages and adjustable-rate mortgages.
A 15-year mortgage can be rigid and unforgiving during buyer’s markets and seemingly cruel during seller’s markets.
Consider the monthly principal and interest payment on a 15-year, $200,000 mortgage compared to a similar 30-year,
$200,000 mortgage. The monthly payment on a 15-year, 4 percent interest rate loan is nearly 42 percent higher than the payment on a 30-year, 4.75 percent rate loan. That higher monthly payment makes a significant difference when trying to buy into a hot market. Housing already is a person’s largest monthly expenditure. To voluntarily add
42 percent more to a payment monthly just doesn’t make sense for many buyers. The 30year payment is more affordable.
Because the mortgage payment on a 30year loan is lower, the homebuyer has two attractive options to consider.
First, they could buy more home. That means bigger, nicer spaces that potentially have better resale options. This strategy arguably could allow a family to grow into their home and not be forced to look for different housing options as their home needs change.
The other option is moderation. The homebuyer could buy a more modest home and use the money saved on other financial priorities such as student loan debt reduction, saving for college and retirement, or properly furnishing the home they just purchased.
In a twist, a 15-year mortgage’s ability to gain equity quickly actually becomes a disadvantage because home equity isn’t a great asset, as asset types go. Home equity has a
0 percent rate of return. In order to access the equity, you must either sell the underlying property or borrow from it.
The lower payment structure of a 30-year mortgage allows you to “invest the difference.” If you calculate the difference between the two loan types, you can secure the 30year mortgage and then invest the difference in a more attractive investment that grows at a higher rate of return and likely is more accessible (without borrowing).
Consider, too, that the 15-year mortgage can be a bigger burden should hard times hit, as it offers little flexibility. And if a person really does want to own their home outright after 15 years, they can simply make higher principal payments using their existing 30year loan. This leaves the option to dial back the extra payments when the family budget gets too tight or life gets harder.