When choosing a mortgage to buy a home or if you already have a home and are looking to refinance your mortgage you should always get a 30 year fixed rate mortgage.
You just should. Yes, take a look at the other mortgages (15 year, ARM, etc.) so you know whats available.
In the end, choosing a 30 year fixed rate mortgage over the others comes down to two things. Flexibility and Security.
Most people consider owning a home a life long investment. We all like to think we will stay in that home until we die but this is hardly the case. Many people move within 5-10 years as families grow, job changes, etc.
With a 30 year fixed rate mortgage your payment will never change until the day it is paid off. What this means is as your life changes your monthly housing costs will not. It’s nice to know your mortgage payment is never going to change.
In some cases an adjustable rate mortgage might be tempting. Especially a 7 year ARM where the interest rate is fixed for the first 7 years. But even then, the difference in interest rates between the 7 Year ARM and a 30 Year Fixed is typically around .25% with the 7 year ARM having the lower interest rate. If thats worth it for the next 7 years than do it. If you don’t want to ever have to worry about your payment moving than the 30 year fixed is what you want.
Stay The Course – Keep making monthly payments as normal for as long as you live there.
Pay It Off Faster – Why refinance into a 15 year loan when you can make larger payments? When you refinance into a 15 year mortgage payment your required monthly payment goes up forcing you to pay more. Pay more to your 30 year mortgage when you can and scale back when you can’t.
Can’t Sell? – Moving and can’t sell your home? What about renting your house? With the 30 year fixed rate mortgage you’ll probably be able to rent your house for more than what your payment is.
Max Out Retirement Accounts – I would make the argument it is way more important to fully fund your retirement accounts every year than pay off your mortgage. You only have so many years to take advantage of compounding returns in a 401k, IRA, or Roth IRA. Wouldn’t it be nice to have those extra couple hundred dollars available every month to be able to put into those accounts.
Stated differently, why would you want to pay down the mortgage you are paying 6% or less on when you could earn 7% or more a year on average in a S&P 500 index mutual fund. Your money is doing more for you in year one versus paying the mortgage off. In year two you would be 8% ahead in return on your investment. And that does not include the tax implications of putting it in those accounts.
Cash Flow – Maybe when you bought the house you didn’t have kids. Five years later you now have two. Even with steady or rising incomes you all of a sudden feel strapped for cash because daycare for two is insanely expensive. Those couple extra hundred dollars you put in your pocket versus on the mortgage are whats keeping you out of debt.
30 Year Mortgage Vs. 15 Year Mortgage
For the sake of argument we have to compare a 15 year mortgage as it’s the other popular choice. It is true that the 30 year fixed rate mortgage typically has an interest rate .5% to 1% more than a 15 year mortgage.
While interest rates are important you need to understand that interest rates are what they are. Of course you should want to get the lowest rate possible when getting a new mortgage but its the payment you should consider first.
As an example.
$150,000 loan at 5%:
30 year payment = $805.23
15 year payment = $1186.19
If you want to pay the house off in 15 years than put an extra $381 on your 30 year payment. It’s that simple.
It’s very common for people to get into a 15 year mortgage and a couple of years later refinance out of it to free up cash flow. Everybody likes the lower interest rate in the beginning but in the end it always comes back to the payment.
The good news for those who did stay in the 15 year for a couple of years is when they refinance into a 30 year mortgage at the lower balance (assuming you are not taking cash out and interest rates are within 2% of your 15 rate) your monthly payment will be ridiculously lower.
Yes, it is pretty sweet seeing the balance on your mortgage go down with a 15 year loan. After year three you start to notice how much you’ve paid off. But take a second and compare what your investment account would have looked like if you would have been putting the difference in payments of a 30 year into a retirement account.
Or even a taxable account if you are able to max out your retirement accounts. You’ll probably be astonished how much more money your money would have made or at the very least the shares it would have bought re-investing dividends and capital gains.
You put yourself in control of your financial position with a 30 year fixed rate mortgage versus other mortgages. The only reason you would refinance out of your 30 year mortgage is if interest rates go down.
And with you having the lowest payment possible with a 30 year mortgage you have now freed up money to max out your 401k, not go into debt, pay for day care, and every other financial reason.
Make sure if you do refinance that the interest savings cover the closing costs of refinancing. Typically if you can save .5% on another 30 year fixed rate mortgage it will make sense.
I’d suggest not refinancing or buying a house with an adjustable rate mortgage (ARM) unless you are absolutely 100% sure you will be selling the house before the interest rate adjusts. Yes, it could go down but it could also go up. Do you want to be paying closing costs again to refinance?
Do yourself a favor and take the 30 year fixed rate mortgage. You will be doing yourself a long-term favor with your finances when you have one.