How to Buy a House home Learn the basics 1. The Basics 2. How much home can you afford? 3. The Down Payment 4. The Loan - Assuming a Loan - Owner Financing 5. Qualifying for a loan 6. Understand Closing Costs Do the groundwork 7. Get your finances in order 8. Check Your Credit Report - Repair bad credit - Establish Credit if you don't have any The Process 10. Find a Lender 11. Evaluate the bank's offer 12. Start looking at houses 13. Get the Disclosure 14. Make an offer / Sign a Contract 15. Have the House Inspected 16. Problems on the Inspection? 17. Renegotiate the terms 18. Appraisal, Survey, & Insurance 19. Appraisal went through? 20. Closing! After the purchase Avoding scams More about Mortgages How much loan can you get? Figuring your monthly pmt. 15- vs. 30-year loans Prepaying your mortgage How to figure mortgage interest Private Mortgage Insurance Paying Points If you won't live long enough to pay off the mortgage Other Topics Renting vs. Buying: Which is better? Homebuyer Tax Credit Buying is an investment Appreciation Paying cash vs. getting a loan The Debt Ratio Tax breaks are actually welfare for the rich Other Links to helpful sites Fan Mail Michael Bluejay's home page Email Me	How to Buy a House As seen in BusinessWeek   and Realtor Magazine   a free 38-page guide by Michael Bluejay ©2000-2010
	15 vs. 30-year mortgages When you buy a home you get a mortgage loan that's paid back over 15 or 30 years. Thirty-year loans are popular because: The monthly payments are lower than with 15-year loans. You can qualify for a bigger loan (i.e., a more expensive house) than with a 15-year loan. Sometimes that's all you can get. (You might not qualify for a 15-year loan.) The downsides of 30-year loans compared to 15-year loans are that you have to make monthly payments for an extra 15 years, and you'll pay a lot more total interest over the life of the loan. Let's take a look at the difference. Feel free to enter in your own numbers for your own situation. Loan amount Interest rate % 15-year 30-year Monthly Payment $ $ Total Paid $ $ Total Interest Paid $ $ Extra interest paid   on a 30 vs. a 15 $   If a 30-year is all you qualify for, then you don't have to worry about choosing between the two, since there's no choice to make. You take the 30 because that's all you can get. But if you can qualify for either, which should you pick? In most cases if you have a choice, you should take the 15. You'll save a bundle of interest and pay off the loan in half the time. Note that even if you take the 30, you can still make prepayments to pay it off in 15 years, and save interest just as if you had a real 15-year loan. An advantage of doing it this way is that you keep your monthly payments low so that if money gets tight, you're not locked into a higher monthly payment. With a 15-year loan you have to make the higher payment every month whether you want to or not. With a 30-year loan whether you make extra payments each month is up to you. So a 30-year loan gives you some extra flexibility. Of course, if you're not diligent about making extra payments on a 30-year loan, then you'll pay more interest Taking a 30 and investing the difference A possible advantage of a 30-year mortgage is that since the payments are lower, you can take the money you're saving each month from the lower payments and invest it in something else. That keeps your investment liquid, so if you run into hard times you can easily turn your investment into cash. If you'd taken a 15-year mortgage your investment would be locked up in your house, and it wouldn't be easy for you to turn that equity into cash. The reason I say this is only a possible advantage is that it requires you to be diligent in investing the difference between the payments each month. And unless you get a great return on your outside investments, you'll wind up with less money. That's why most people should just get a 15 and not worry about all this. You should invest the difference to keep your capital liquid only if: You're diligent about investing the difference each month, and You're either getting a great return on your outside investments, or you're willing to sacrifice some return in order to keep your capital liquid. Let's see how this works. Let's say your payment would be $1100/mo. on a 30-year loan vs. $1500/mo. on a 15-year loan. Instead of taking the 15-year loan for $1500/mo., you take the 30-year loan for $1100/mo., and invest $400/mo. separately somewhere else (mutual funds, high-yield CD's, socially-responsible stocks, etc.). By doing this your investment remains liquid. Your house is an investment, sure, but you can't eat your house. Any money you put into your house is money you can't easily get back out. The only way to monetize that investment is to sell the house or borrow against it (refinance or home equity loan). And if times get tough (like you lose your job), then ironically no bank will let you borrow against your home because they're worried that a jobless person won't be able to pay them back. By contrast, if you invest your cash in mutual funds or other similar investments, it's always easy to sell them to access your cash. How much you sacrifice for this flexibility depends on what kind of return you can get on your other investments. In a scenario I'll run below on a $150k home at 5.75% interest, investing your extra cash elsewhere at 5.25% means you'll pay an extra $143k over the life of the loan, vs. getting a 15-year loan. Now we'll see why this "investing the difference" idea isn't the goldmine some seem to think it is. Why "investing the difference" doesn't always work Some writers feel so strongly you should take the 30 that they so far as to say that 15-year mortgages are a "sucker's bet"! Dan Green says that by investing the difference in payments, you not only keep your cash liquid but you wind up making more money because you get a bigger tax break on the higher interest. I think Mr. Green is wrong. He appears to have made a number of mistakes in his analysis. First of all, he says, "Because mortgage interest is tax-advantaged, we will want to keep the interest as high as possible for as long as we owe money on the house." No, you do not want to keep the interest as high as possible, because the cost of the interest is way more than the amount of the tax break. Trying to keep your interest payment high is like spending a dollar to save a quarter. Second, he assumes that every dollar of mortgage interest is deductible, but that's not the case. The IRS lets you "itemize" all your deductions on Schedule A, or you can just take a blanket $5000 deduction. Let's say you itemize $7,000 in mortgage interest and $2500 in other deductions, for a total of $9,500 in deductions. If you didn't itemize you'd still get the $5,000 standard deduction. So the extra deduction you get from itemizing is only $4,500 ($9,500 - $5,000). So the mortgage interest deduction reduces your taxable income by only $4,500, not the full $7,000 of mortgage interest you paid. Third, he assumes you're in a whopping 33% (!) tax bracket. Most Americans aren't rich and pay a much lower percentage of their income in taxes. Fourth, he assumes you'll invest your annual tax savings. This is wishful thinking. I can imagine maybe 1 in 1000 people actually being dedicated enough to follow that plan. Fifth, he's not considering that the money in your outside investments is taxable. If you make 5.25% from your investments, but you're in a 25% tax bracket, your effective return is only 3.94%. That dramatically reduces the amount of return you make from compounding. Finally, I'm not sure he's considering that with a 15-year loan, it's paid off in year 16, and then you can start investing the money you're not spending on mortgage payments into something else. I can't tell for sure whether he's omitting this because the images on his page don't load. Put all this together, and we see that 15-year mortgages easily beat 30-year notes: 15-year 30-year Basics $150,000 $150,000 Loan Amount 5.75% 6.00% Interest Rate $1,246 $899 Monthly Payment $224,211 $323,757 Total Payments $74,211 $173,757 Interest paid Rate of Return 5.25% 5.25% Return on other investments 3.94% 3.94% Rate of return after taxes (25% bracket) Investment income + tax savings $304,973 Income from taking the $1246/mo. that we no longer have to pay the bank, and investing it elsewhere for years 16-30 $238,682 Income from taking the 30-year loan and investing the difference between 15- and 30-year payments, over 30 years $24,900 Tax savings on extra interest paid (see note below) $304,973 $263,582 Total investment income + tax savings Results $232,762 $89,825 Net gain (investment income + tax savings - interest paid) Here's why a 30-year can't beat a 15: You pay more than twice as much interest with a 30. In our example, you pay $173k vs. $72k. Investments with a 30 are weaker than with a 15. There's no magic to "taking a 30-year note and investing the difference", because the return from doing so is actually less than the returns from investing with a 15-year note. The tax advantages on a 30-year mortgage are tiny. They don't come close to making a 30-year note more attractive than a 15 -- even if you're in a high 33% tax bracket.  So with a 15-year loan you come out way ahead. You save a ton of interest, and your outside investments are stronger. Fifteen-year mortgages are for suckers? I don't think so! Please do note that even though the 30-year note is more expensive overall, it does let you have easy access to your capital, if that's important to you. It's just that in exchange for that flexibility you'll pay a lot of extra interest and earn less on any outside investments.. Some final notes on the numbers in the table: The rate of return on other investments is all-important! If your rate of return is less than what's listed in the table, the amount you forfeit by going with a 30-year mortgage vs. a 15 is even greater. The tax savings are a rough estimate. I first figured that on a 30-year loan you pay $323,757 - $224,211 = $99,546 extra in interest, which is $3318 extra in interest each year. In a 25% bracket, that's $830/yr., or $24,900 over 30 years. Here's my Google Spreadsheet which has a little more detail about the numbers in the table.   Related topics: Prepaying a mortgage Understanding compound interest Figuring your monthly payment  Last Update: Februray 2008