15 vs 30 year fixed and how much down payment!?!
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.
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.
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.
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.
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.)
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!