No matter what type of fixed-rate mortgage you are looking at, the same principle applies: The longer you take to pay it back, the lower your monthly payment will be. But since you will make more monthly payments for a longer period of time, you will pay more interest over the life of the loan -- a lot more.
If you refinance or sell the house before the loan is paid, you still wind up with less paid equity than you would have had you taken a shorter-termed loan. So, even though the monthly payments are higher on a 15-year loan, you pay less interest and build equity faster than with either a 30-year or a 40-year mortgage.
Aside from the math involved, which we will look at later, the other factor that makes 40-year mortgages more expensive than 30-year loans, and 30-year mortgages more costly than the 15-year variety is the simple fact that the longer the loan, the higher the interest rate. The numbers hold true if you look at them in terms of either the money you spend every month or the amount of paid equity that you have accumulated.
Before you buy a house, you have to answer some very important and personal questions: How much can you afford to pay every month? How much are you willing to pay? Would you rather pay off the loan slowly and have more available cash, or pay it off as quickly as possible and have less to spend every month?
These are personal decisions, and no one can say that one or the other is right or wrong. To be honest, an awful lot of us don t have much choice in the matter. We pay off as much as we can no matter how long the loan might last. Period.
Regardless of why you choose the mortgage you do -- for 15, 30 or even 40 years -- it is important to know how much it is actually costing you, and why. So let s look at a $100,000 loan over each of those periods.
With good credit and a suitable down payment, you could probably get a $100,000 mortgage for 15 years at 6 percent. That same loan over 30 years would probably cost you 6.25 percent. For 40 years, it would be 6.5 percent. The reason the interest rates climb along with the length of the loan is because a longer-term loan is riskier and lenders have to wait longer to be repaid.
Now let s look at those loans in terms of basic monthly payments -- just the interest and principal. These numbers do not include taxes, insurance or any fees or assessments. For the 15-year loan at 6 percent, the monthly payment would be $843.86, and were you to keep the loan for the full 15 years, you would pay $51,893.80 in interest. For 30 years at 6.25 percent, the monthly payment would be $615.72 and the total interest you would have paid by the end of those 30 years would be $121,656.04. For 40 years at 6.5 percent, it s $585.46 a month with interest payments totaling $181,013.42.
There is a certain amount of industry speculation about 50-year mortgages. If they do become common, no one knows for sure what sort of interest they will require. If they were a quarter-point higher than a 40-year loan, the monthly payment on $100,000 would be $582.63, giving you a negligible savings of just $2.83 per month when compared to a 40-year loan. Even if you could get a 50-year loan at the same interest rate as a 40-year loan, or 6.5 percent, the monthly payment would be $563.72, for a savings of only $21.74. So, while the difference between a 15- and a 30-year loan is a significant $228.14 a month, the difference between a 30- and a 40-year mortgage is only $30.26 -- and we ll ignore the 50-year loan.
How much is the payment? is invariably the first thing a prospective borrower will ask, but another important question is, How much paid equity are you getting for your money? In other words, at the end of the first year, how much of the home is yours? How about after the fifth year?
Most homes do increase in value, but it is impossible to predict either how much or how fast. You do know, however, how much you reduce the principal every month by making payments. After one year with the 15-year mortgage, you would have lowered the principal to $95,758.29 and have $4,241.71 in paid equity. With the conventional 30-year mortgage it would be $1,117.83, and with a 40-year loan, only $541.46. After five years, the person with the 15-year loan would have $23,991.12 in paid equity and would have reduced that $100,000 loan by close to 24 percent -- nearly one-quarter. For the 30-year buyer, the paid equity would be $6,662.96, and the debt would be lowered by about 7 percent. With a 40-year mortgage, the total paid equity would be $3,095.05 and only slightly more than 3 percent of the principal would be paid off.
Now a lot of us have no choice in the matter. We sign up for the mortgage with the largest monthly payment we can afford, no matter how long it might take to pay it off. If you can afford it, you might want to consider making a slightly larger monthly payment, depending, of course, on your long-term goals. Even if you plan on selling the house and moving in a few years, your paid equity gives you access to more money that you can put into a down payment on your next home.
The thing to remember is that unlike a 15-year mortgage, where each payment takes a noticeable bite out of the principal, payments for a 30- or 40-year loan do more chipping than chopping. But no matter which loan you choose, the principal is being reduced. You also are living in your own home and the interest is tax deductible, which takes some of the sting out of the payment and may even qualify you for a tax refund. That might let you do something nice for yourself -- like making an extra payment to build your equity more quickly and make that much more of your home really yours.