15 vs 30 year fixed and how much down payment!?!
Hey everyone,
I'm not sure this is truly the right category for this, but my question is investment adjacent.
I'm preparing to buy a home in the next 2 years (market willing), and I'm building several scenario calculators in excel with different down payment amounts and mortgage terms. I'm planning to have somewhere between 10% and 20% saved by Jan 1, 2022, which is when I plan to start house shopping in earnest. I can save up about 4-5% of the expected housing price per year.
When it comes to down payment amount and length of mortgage, I am torn and can't find great advice online other than "do what feels best for you". That's not good enough. I need hard numbers, at least inasmuch as I can estimate.
So here are my considerations:
1. Down Payment: A larger down payment (20%) means more time renting before buying, a lower monthly payment and/or a lower total mortgage, and generally a lower APR. That money can earn interest while it's being accumulated, but I don't want to put it in stocks so it probably won't beat inflation.
A smaller down payment (10%) means buying sooner, a higher monthly payment and/or higher total mortgage, and a generally higher APR along with PMI. However it means getting out of renting sooner (and life is short!). I can calculate the cost difference between a larger and a smaller down payment for the same sized property with PMI and APR estimated.. but...
What I'm really concerned about is the opportunity cost of money. A small down payment doesn't just give higher monthly payments, it also frees up some (potentially not yet earned) money for other investing purposes. Given how low mortgage rates are now, and crossing my fingers that they'll stay low, would it make more sense from a financial perspective to pay a smaller down payment and invest the difference over the life of the loan?
2. Mortgage term. My gut feeling is that a 15 year fixed is a holy grail that I should grab if I can afford it, but my brain tells me otherwise. Basically, a 15 year fixed means lower total interest paired with higher monthly payments, but the opportunity cost of money pops up here again too, and this time inflation as well. One of the great benefits of a mortgage is the inflation security. Cost of living goes up, rent goes up, incomes (hopefully) go up, but a mortgage payment stays fixed. On the other hand it seems like inflation has nowhere to go but up right now, and investments should also inflate as well (I think) over the long term (30 years). With low mortgage rates now, the benefit of paying off the mortgage early is less, while the inflation security is there regardless. This makes me think a 30 year fixed has more upside than a 15 year fixed, and I can always put more money into the mortgage if for some reason stocks look insecure...
I really just want an informed discussion and maybe a consensus around at least what the key factors in play are, and how strongly to weight each.
Also if you have any tips, I'm a first time homebuyer and would love your advice.
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I'm far from a mortgage expert, but I think that in some cases your interest rate can actually be a little higher on a 15 year mortgage than a 30 year mortgage. On my latest refinance, I opted to go for the 30 year loan again since there's almost no chance that we'll be in this house for payoff so the increased market value is what's driving our equity and not our payments. As long as you don't have a penalty for early payment you can also leverage the flexibility of a 30 year loan and make your own plan for paying it off in whatever timeframe works best for you. The downside, of course, is it's easy to spend money on other things when there isn't a forced payment.
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blackdiamond I'm curious about your plan to sell before payoff. Doesn't the 30 year mortgage push your break even on resale further into the future?
Assuming you have a time horizon where investing is a possibility, would it make more sense if income went up, to put that new income towards investing instead of paying the lower rate mortgage off first? I guess some of this has to do with fiscal and job stability, but if investing is an option and the time horizon for that money is long enough (decades), then investing seems like the obvious choice.
On the other hand, if money is tighter and you might need that invested money sooner or in the same timeframe you plan to sell the house, paying the mortgage down is a safe(er) option that still returns more effective interest than other secure investments. Maybe this is another example of how being poor (relatively) makes you poorer?Edit: I kind of mixed my replies to yours and dakinemaui's comments, so if you're confused about the income bit that's why.
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Scott - The primary reason we refinanced was to roll in a HELOC that we took out to cover a residing project on the house. The combination of the lower interest mortgage (much better than the HELOC) and going back to 30 years kept the payment about the same. The calculated break even point was under two years, so that wasn't a concern.
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You don't need to get this perfect. You will very likely sell before the debt is paid off. The real benefit to owning is the appreciation, monetarily speaking.
Yes, there are rate differences between 15 and 30 year terms. However, the lion's share of the interest paid over the respective terms of the mortgage are due simply to the term length. In other words, there's not a huge difference between paying a 30 year loan off in 15 years and an actual 15 yr term. That means don't worry about "having" to take a 30 year loan right now. If you later get a raise, you can simply make the correspondingly larger payments. Whether it's better to do this or refinance down the road will depend on the rates at the time. My point is you can achieve a shorter term (regardless of what the loan term is) if you throw more money at it. The flip side is not true -- you cannot extend the timeframe on a 15 yr loan, so make absolutely sure you can afford the larger payments required by the 15 yr loan.
Lastly, the opportunity cost is pretty real. Paying down a 3% mortgage aggressively (i.e., 15 yr term) may not make a lot of sense in the face of larger gains at fairly low risk over the timeframes considered.
My advice: get something that will probably appreciate at a 30 yr term loan (with a down payment that is sufficient to make the payments affordable) and see what life brings your way.
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dakinemaui This lines up pretty well with my thinking. I'm hard pressed to think of a scenario where I'd want to pay off a low interest mortgage faster than minimum payments over the longest time horizon.
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Another strong vote for a 30 year loan which gives you much more flexibility. You can pay it off fast if you want or pay it slow and invest (my choice). As far as 10% vs 20%? Dealer's choice. I hate PMI but eventually, you can get rid of it. I personally wouldn't put down more than 20%.
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Superbone This got me thinking, as long as the mortgage API plus the PMI is below the long term market return rate, wouldn't it make sense to pay as little down as possible on the condition that I need to be investing the difference? The PMI is the cost of having more money on hand to invest, and the market should, in the long run, pay back the PMI cost and then some, right?
(I use a fairly conservative 6% guesstimate for market returns. Either we're into the realm of Modern Monetary Policy and the old rules no longer apply to anything, or we're due for a period of years where the average return compared to inflation is much lower than it's been in the last 50 or so, as far as I can tell). -
Scott You might not be in the house long enough for the market return to beat the interest rate. I would put down 20% and avoid PMI because it's just throwing money away for no good reason unless you live in an area where housing is unaffordable.
Let me give you a data point. I bought a house in 2003 and sold it in 2014. I sold it for $10k than I paid of it. Additionally, the market was flat during most of that time period known as the Lost Decade. Paying off my loan would have come out ahead... however really we did neither because we were stupid with our money. We weren't putting enough in retirement accounts and we were only paying a little extra on the mortgage.
P.S. We also sold our second house for a $10k loss.
Everyone is right about turning a 30-year into a shorter term by paying more, but one should also specifically look at the rates and run the numbers. Sometimes the difference in rates of different terms can make a significant difference. I've had 3 houses with 6 different mortgages. I went from 30 to 30 to 30 to 20 to 20 to 15. We're on our 3rd house in our mid 40s and the goal is to be done with mortgages by the time we retire. At the time of our most recent refinance, the 15 year was about 0.5% better than a 20 or 30.
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I have had both 30 year fixed mortgages and 15 year fixed mortgages, with my latest refinance being into a 30 year fixed at 3%, after having just refinanced from a 30 year fixed at 4% to a 15 year fixed at 3.15% in December of 2019. But I couldn't turn down the option of a lower interest rate AND the longer term.
With mortgage rates as low as they are and with so much uncertainly, I liked having a lower payment and a really low interest rate. I used to have plans to pay off my mortgage early, but at this point, with 3% interest, I'm probably just going to pay my required payments and let inflation eat it away, since that low interest rate on a 30 year mortgage is a great inflation hedge. I still want to feel what it feels like to own my home outright someday, but I have a feeling it will almost feel like that in 15 years when my payment is still what it is now, which is already pretty low.
I think a longer term at this point with the lower payment is a wise move if you buy right now, with all the uncertainly in the economy. You can always pay it like a 15 and the interest rate will be pretty similar so it won't change that much.
As for a down payment, I would I would look at what kind of home you want in what area, how much that will cause, and what size mortgage you qualify for at what interest rates before I invest too much time in that decision, then figure out whether that payment will fit in your budget with a smaller down payment. I bought my home with~8% down, but got rid of PMI fairly quickly because of prices going up so quickly. Buying when I did was a good move, but I only know that now, after the fact.
As with everything in PF, it's really all about your priorities.
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PhysicsGal That's fantastic to get such a low rate on a 30 year. Absolute no brainer to take it, and congratulations! Out of curiosity, what were the costs of refinancing, and did you calculate them into the total cost of the new 30 year mortgage?
Fortunately, there's no real concern about not qualifying for the mortgage I want. I'm more concerned about making sure the mortgage and the house are aligned as best as possible for financial well being.
Were you able to pay off your PMI early? How does that work?
I've seen a lot of articles hinting that now is a good time to buy, but it feels like a horrible time to buy. All the homes that might hit the market due to the downturn haven't yet, but everyone who was waiting to buy is out shopping. Prices only dipped slightly in my area before climbing again. I have a feeling that the housing market will be as close to a buyer's market as it's going to be starting around early to mid summer next year.. but if that happens I'll only have about 7% down payment saved up. All the more reason to choose lower payments and a longer loan term I suppose. -
Scott said:
Were you able to pay off your PMI early? How does that work?About a year after I bought the house the value went up enough that I was already at 80% loan to value. I ended up needing to refinance into the 30 year fixed at 4% from an original 15 year fixed at a rate I don't even remember (maybe 3.75%?) due to life circumstances, so when I did the refi, PMI went away. Gosh I hope this is my last mortgage on this house!
Scott said:
Out of curiosity, what were the costs of refinancing, and did you calculate them into the total cost of the new 30 year mortgage?I went with a local credit union and the costs were ~$3k and yes, I just rolled it all up into the mortgage. I also had the new 1st mortgage pay off my home equity loan, so my loan balance is higher today than it was a year ago, but my payment is less. I highly recommend shopping around a bunch for the best rate and closing costs and definitely include some local credit unions in that search. Just do the shopping close together in time because I think the hit to your credit will be less than if you wait in between hard pulls.
I would get a real estate agent and get your agent to take you to a few different neighborhoods and homes in them to get an idea of what to aim for. When I bought the house it was 2011, a buyers market, but it took almost 6 months of looking at so many awful houses before finding this one that I really love. I was shopping while continuing to save for my down payment.
Dave Ramsey actually has some great advice on buying real estate that you might want to check out. He says the best way to win with real estate is to get a really good deal on the buying side by overlooking things that other people will not, like cosmetic issues, but to buy a house with good bones in a good location.
Happy house hunting!
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We did something similar to you, PhysicsGal as well. We had to have PMI because we weren't putting enough down, but after 6 months we were able to refinance to get out from under the PMI. That brought our payment down by $100, but then taxes ate that back up in escrow, so it went back up again.
As far as the hits to your credit report, I think if you do it within 30 days, then it is only counted once, so you can search around a couple different places and as long as it's within 30 days it doesn't ding your credit for multiple hits. Check that with someone smarter than me, but I recall seeing that after we just got the BF set up in a car, and he applied for a loan a couple different times over the course of a couple months, and hit credit got dinged pretty hard for it.
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Another vote for the 30 year - as it's already been said, you can make additional payments over and above what your monthly payment is, but you can not make the monthly payment smaller if things get tight. Take the lower monthly payment and longer term because it gives you more flexibility and control of your money. (I threw our mortgage numbers into undebt.it not long ago, and discovered that if we only added an extra $250 to our payment, we would be able to cut our 30 year down to 15, and save a boat load in interest. A little bit can go a long way when you're talking about working with 30 year numbers. If only we had the extra $250/month to actually make that happen. Our philosophy is to get the equity out of the house improvements since we purchased a 1960's house that has not been updated, but is clean and has strong bones. So we'll get our gain when we sell after we've renovated and improved everything. Worst case scenario if the market tanks we won't lose value due to the improvements and it will be a wash. The same won't be said for all of the younger family that bought monster sized new houses with all the upgrades. They have no where to make improvements so they don't lose value.)
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Jesse had a great blog post on the 15 vs 30 year mortgage debate recently! For another take.
When you're looking to purchase or refinance (currently in the process myself), you can feel a bit like Vizzini... which to choose?
Happy house hunting!-
Nicole That was a great article, much more in line with what I need and hit the exact same concerns I was having.
My only follow-up question to that article would be the difference in interest paid between the 15 year fixed and the 30 Year fixed if paid off in 15 years, since that's the price of buying flexibility. I can calculate this but it would be nice to see in the article.
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Scott Best calculator I've found for evaluating such differences is here: https://www.hughcalc.org/loancomp.cgi
It's nice in that it considers closing costs, that you'll be saving/investing money you save on interest (and don't send to the loan) and also that there is a tax break for mortgage interest.
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dakinemaui I've been using that calculator for years. It's really good for this exact purpose.
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dakinemaui Just wondering how you know these days what you should use as the rate of return to use on your investments? I haven't really looked at the tool yet, but I assume it doesn't automatically assume you can deduct mortgage interest. We could until 2 years ago and now we can't.
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Periwinkle Flute Now that you say that, I don't believe it does assume mortgage interest deduction. (I previously misspoke.) As far as investment return, that's up to your risk tolerance. I typically use 2%. Higher values delay the break even point.
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dakinemaui Periwinkle Flute Honestly I have always used the present savings account interest rate. Unless you are planning to invest the money in stocks, that's about how well you're going to do.
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In July, I refinanced from a 3.25%, 30 year fixed loan to a 2.875%, 30 year fixed loan. This resulted in a payment of $200 less per month. I'm putting that extra $200 per month into the stock market.
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Superbone I am surprised it was even worth refinancing with only saving 0.375% interest. You must have actually added more years when you refinanced to get that kind of savings or have a huge mortgage in the 1 mil range.
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ynaber2613 First of all, it was a no-cost refinance. Secondly, yes, I was 4 years into the previous mortgage so I added 4 years. Thirdly, it's a third of a mil (HCOL area and this is one of the less expensive homes). Fourthly, this is not my forever home and I'll be selling in about 5 years +/- so adding years doesn't matter to me. More money in the market does.
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Superbone I knew you had all of the bases covered. I was just curious about such a low interest reduction. You are probably correct in that investing the payment savings will gain more than the equity gain. I know in my area home prices have gone up due to the low interest rates. I would not be surprised later on if they start raising rates that home values will start to go down again.
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ynaber2613 said:
I would not be surprised later on if they start raising rates that home values will start to go down again.There's definitely a correlation between those two.
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Superbone Positive or negative? 😛 Supply and demand is obviously inescapable, and demand wanes with higher rates. However, a recovering economy may add pressure to increase demand due to increased job stability as Covid vaccinations come around (someday).
Time will tell, of course, but I suspect values will continue to rise.
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dakinemaui It will be interesting. Normally the housing prices go up as the interest rates go down (and vice versa) as people can afford more house with the lower mortgage rates.
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