Buying a home or refinancing? A 30-year mortgage may not be your best option

If you’re thinking of buying a home or refinancing one, a big question will be whether to get a 30-year mortgage or opt for a shorter term loan.

Most people get a 30-year fixed rate mortgage, which offers lower monthly payments. But there are still some instances when it might make sense to consider a 15-year or 20-year mortgage. Such loans will require you to make higher monthly payments, but they come with lower interest rates, and they let you build up equity in your home much faster.

“A 30-year fixed rate mortgage isn’t always the best for a consumer. Most people are singularly focused on monthly payments. But owning a home is not just putting a roof over your head. It’s part of your overall financial plan,” said Brian Blonder, senior vice president of residential lending at Capital Bank N.A., in Maryland.

Here are five questions to consider when making your decision.

1. What are the cost differences?

Say you borrow $300,000 to finance your home. A 30-year mortgage at 3% will cost you $1,265 per month, and $155,332 in interest over the life of the loan.

By contrast, a 20-year mortgage at 2.75% will increase your monthly payments by $361. But it will cut the total interest you pay on your home by nearly $65,000. A 15-year mortgage at 1.99% will cost you $661 more per month, but save you more than $108,000 in interest costs over the life of the loan. (Use this calculator to figure out how much your mortgage payment might be.)

2. What are the tax implications?

There are typically two big tax benefits to owning a home, regardless of which type of mortgage you get: the ability to deduct the mortgage interest you pay, as well as state and local property taxes.

But that only matters to you if you itemize deductions on your federal return, which just a small minority of tax filers do because for most people it is more advantageous to take the standard deduction.

If, however, you do itemize, ask an accountant if the tax savings you’d realize on a shorter-term loan, say a 20-year mortgage, might make it affordable for you, and therefore an attractive alternative to the 30-year, given your financial goals.

For instance, while you’ll pay about $361 more per month on the 20-year loan in the $300,000 example above, you might reduce that amount substantially through tax savings if you’re in, say, the 25% tax bracket, Blonder said. For instance, you’ll save $2,062 in taxes on your interest payments alone in the first year. Divided by 12, that comes to $172 in tax savings a month. You’ll also save $750 a year, or $63 a month, if you’re paying $3,000 a year in property taxes.

So now that $361 extra in monthly payments is effectively just $126 more, Blonder explained.

You can do similar math on your 30-year mortgage — the net monthly payment also will be lower due to tax savings if you itemize.

Once you compare the two monthly payments after taking tax savings into account, the question then becomes is it worth it to you — and affordable — to spend a bit extra on a shorter-term mortgage in exchange for building equity more quickly and substantially reducing the interest you pay to own your home.

“If one of your objectives is to build wealth, then is it worth it to reach a little further and spend an extra $100 to $200 a month to substantially accelerate growth in your net worth?” Blonder said.

3. What else are you doing with your money?

If you’re really stretching financially to buy a home, a 30-year may be your best bet because it offers the lowest monthly payments and you may need every dollar left over just to meet your other essential expenses.

But if you expect to easily have some money left over every month with a 30-year loan, then consider where you’ll get the most bang for your buck with that money, suggested Mari Adam, a certified financial planner in Boca Raton, Florida.

Since 1987, the annualized return on home prices is 4.2%, according to the S&P CoreLogic Case-Shiller National Home Price Index.

So if you’re planning to bank your extra cash in a savings or investment account that yields less than that, you might be better off putting that money instead toward a higher monthly payment on a shorter term loan or making extra payments on your 30-year loan, Adam said.

But, she cautioned, “make sure you can make the bigger monthly payments without question.” That is, you have enough in emergency savings and other liquid assets to cover you in the event of a job loss or other unanticipated hit to your cash flow.

4. If you’re refinancing, how much time is left on your current mortgage?

If you’ve been in your home for several years and want to refinance to lock in a lower rate, don’t opt for another 30-year loan, Adam said. “If you have 10 years left, refinance for 10 years. [Otherwise] you’re paying the highest amount of [total] interest. Just replace what you’ve got left on the clock unless there’s an extenuating circumstance.”

By extenuating circumstance, she means an unexpected hit to your finances, such as a job loss or divorce, which may put you at risk of losing your house unless you can cut your monthly payments substantially.

5. Do I want to pay off my home and if so, why?

Are you someone who simply wants to pay off your debts as soon as possible and pay less to the bank? If you can afford to take one, then a 15- or 20-year loan may be your best option, Blonder said.

As home buyers age, they may start to think about what they want to leave their children or simply like the idea of being debt-free in retirement.

Adam urges you to consider the counterargument to both those desires: You always need to do what’s best for yourself financially, and that will depend on your needs and your expected cash flow from your retirement assets and fixed income, such as Social Security or a pension.

“It’s not about your age. It’s about what leaves you in the best position to use your money wisely. Cash poor is not smart. Having cash in your pocket to have a better life when you’re older [is].”

As for your kids, if you can live well and leave them something when you’re gone, great. But if not, that’s okay, she said. “Your kids can sort through their own lives.”

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