DEAR MR. MYERS: We are planning to buy a new home, so we have followed your advice by checking the rates and terms offered by several different banks and mortgage brokers. Two of them suggested that we consider a 15-year loan instead of a 30-year, because the 15-year loan would have a lower fixed rate and we would save a lot of money by paying off the mortgage in half the usual time. We think that this sounds like a great idea, but what do you think?
ANSWER: I think that choosing a 15-year term over a 30-year repayment schedule is a good idea for many home buyers and refinancers, provided they can comfortably afford the higher monthly payments that the shorter-term loan would entail.
Rates on 15-year mortgages usually are about one-half of a percentage point lower than those on their 30-year counterparts, in part because the shorter term cuts the lender’s risk, posed by future inflation, in half. The nationwide average rate on 15-year loans stood at about 4 percent at the start of May, according to a survey by hsh.com, while rates on 30-year mortgages had climbed to nearly 4.6 percent.
Choosing a 15-year mortgage allows borrowers to own their home debt-free in half the usual time, and can slash more than 50 percent off the overall finance charges that a 30-year loan would involve. But many applicants won’t even inquire about such so-called quick-pay mortgages because they think that their monthly payment would be twice as large as those required by a 30-year payback schedule. They are mistaken.
To illustrate, monthly payments for principal and interest would total $1,025 if you obtained a $200,000 mortgage at the recent 30-year fixed rate of 4.6 percent. Payments on a 15-year loan at the lower rate of about 4.0 percent would be $1,479, or $454 (44 percent) higher.
Sure, finding an extra $454 a month to choose the 15-year option would be difficult for a lot of borrowers. But if you could swing it, you’d not only own your home debt-free in half the time, but also would save a boatload of interest: Finance charges over the course of the 15-year loan would total $66,288, compared with a much steeper $169,104 if you stretched the repayment over 30 years.
In other words, choosing the shorter-term loan over a 30-year schedule would leave you an extra $102,816 to supplement your retirement income, help to put your child or grandchild through college, or spend any other way you wish – all without worrying about making an additional 15 years of housing payments.
Despite the benefits that quick-pay loans can provide, they’re clearly not for everyone. Because monthly payments on the loan would be larger than they would be under a 30-year schedule, your income would have to be higher to qualify. You should shun the shorter-term loan if the higher payments would make it tough to pay other bills – or prevent you from keeping an amount equal to at least six months of your pay in a savings account to make ends meet if you get laid off or encounter unexpected expenses in the future.
You also might want to pick the longer-term repayment plan if you’re a savvy investor who could use the cash that its lower payments would free up to make promising investments.
REAL ESTATE TRIVIA: When leaders of the Federal Reserve Board recently hiked the rates that banks could charge other lenders for overnight borrowing, they also confirmed their plan to make two more quarter-point increases later in the year to quell inflation – the first coming as soon as their June meeting. There’s little question that mortgage rates will keep rising.
DEAR MR. MYERS: Is the damage that was caused by the recent tornadoes and hailstorms that hit several states covered by a typical homeowners insurance policy?
ANSWER: Yes. Damage or destruction caused by tornadoes or windstorms, as well as by hail, is covered by a standard homeowners insurance plan.
DEAR MR. MYERS: If I create the type of basic living trust that you often recommend, could I leave my home to my kids but my other assets to my college alma mater?
ANSWER: Sure. Like a will, a trust allows you to leave some of your possessions to your offspring, others to a friend, and still others to a college, charity or other group. But unlike a typical will, creating an inexpensive living trust will allow those heirs to avoid the costly and time-consuming probate process after you die.
David W. Myers’ column is distributed by Cowles Syndicate Inc.