Mortgage Loans Over Time
I’ve got news for you: the price tag on that house of yours isn’t really what you’re paying for it.
It’s important that you understand the implications of every aspect of your mortgage. You need to see how the length of its term affects you, and you may not be cognizant of this if you haven’t already taken a moment to stop and consider it. Let me preface the rest of what I am about to say by telling you that it’s more important to make your payment every month than it is for you to worry about getting a loan with a shorter term that you can’t as easily afford. Time flies when you’re having fun, but I want you to be aware of what time does when you owe someone money.
Loan instruments are available to suit just about everyone’s personal needs because, well, they make it easy. Anyone who could potentially earn money by giving you money is going to create as many paths as they can to allow that to happen. So while the standard mortgage is setup to last thirty years, there are also standard 15-year mortgages, along with less common 10- and 20-year loans. With the recent housing boom we’ve seen the advent of the 40-year loan, which as I will explain in a moment, is a ridiculous proposition.
Length Matters
As you may or may not be aware, compound interest on a loan is always paid on the remaining balance of that loan. The shorter your loan term, the larger your payments have to be to get that loan paid off in time. The loan balance is reduced more quickly and the amount of interest you’re paying on that balance is likewise decreased. Interestingly enough, the amount you have to pay extra on a shorter loan is not as much as you might think.
What if I told you that there was a way you could save about $140,000 on a $200,000 house? That would sound pretty ridiculous. Well, technically you could. That doesn’t mean you’d buy the house for $60,000. A home costs much more than the sales price when you factor in interest, but by reducing your loan term you end up saving an incredible amount of money.
$200,000 @ 6.5%
30 years: $455,088.98
15 years: $313,598.65
Difference: $141,490.33
With a total cost of over $455,000, you can see that after you’ve added interest into the mix that $200,000 house starts to look a little bit more expensive across thirty years. So why wouldn’t everyone just go with a 15-year loan instead? That’s pretty simple; it’s a little thing called lifestyle.
While the 15-year loan in the scenario above would find you with a paid-off house (and thus without any payment at all) in half the time, the shorter loan does come with a short-term price: $478.07. That’s how much more your monthly payment would need to be for those fifteen years to make the shorter loan happen. Aside from the people who may not be able to afford this higher payment, there are many others who can but simply don’t want to go without the extra cash. Our lives revolve so much around instant gratification that it’s hard for anyone, myself included, to think about forking over another $500 for no immediate, tangible benefit.
Pre-Payment
Still, there’s good news for those of you who might already be on the big thirty-year lockdown. You can add extra to your monthly payment whenever you want, and because of how interest works this amount goes directly toward paying down the principal. The vast majority of mortgages will allow you to do this, except for crappy ones that charge fees when you pay more than you have to. Check with your loan officer to make sure you have this option. It just might save you some money!