house

Should you get a 15 or 30-year mortgage?

If you have asked yourself “Should I buy a home or keep renting” and properly considered the pros and cons of buying vs renting a home, you may choose to buy a house. After checking your credit, thoroughly considering your budget, and getting prequalified for a loan from the bank, you may have found a house you like. Now you need to decide what type of mortgage term is best for you.

 

Point 1: Real estate investors may want a 30-year mortgage

If you are a real estate investor who is buying a home for the sole purpose of using it as an investment property that you rent to someone else, then it is generally best to opt for a 30-year mortgage. As a real estate investor, you are using your tenant’s rent payment to pay off your monthly mortgage, so you are less concerned with paying off your mortgage as quickly as possible. Plus, opting for a 30-year mortgage lowers your monthly mortgage payments to the bank. This means you get to keep a larger portion of the rent your tenant pays you. Opting for a 30-year mortgage instead of 15-year mortgage as a real estate investor creates more cash flow each month, which increases your passive income.

 

Point 2: Deciding on 15 or 30-year mortgage varies based on your circumstances

The decision to get a 15 or 30 year mortgage is not as black and white for residential homeowners. If you are buying a home to live in yourself, the optimal loan term depends on factors unique to your own circumstances. For starters, the bank only offers 15 year mortgages to people who meet certain criteria. Only people with a certain credit score and debt-to-income ratio are eligible. Secondly, a 15-year mortgage has the advantage of offering a lower interest rate than a 30-year mortgage. This lower interest rate will save you lots of money over time. I’ll expand on this with the next point.

 

Point 3: A 15-year mortgage saves you money in interest payments

The main perk of having a shorter loan term, like a 15-year mortgage, is that your interest rate is lower AND the time on which you pay interest is shorter. Both of these factors save you lots of money in interest over the life of the loan. For example, let’s say you and your spouse want to buy a home that costs $250,000. Let’s also assume that you saved up 10% for a down payment (or that your parents gave you a very generous wedding gift for $25,000 that you then used on your home). If you chose a fixed 30-year mortgage with a 4.5% interest rate, by the end of the 30 years you would have paid back the $225,000 you borrowed PLUS an additional $185,000 in interest fees. You nearly paid double for the house!

However, if you had instead taken out a fixed 15-year mortgage (which usually comes with a lower interest rate, so let’s say 3.75% interest), then you would have paid back that $225,000 in 15 years in addition to paying only $69,000 in interest. By opting for the 15-year mortgage you paid off the home in half the time and saved $116,000 in interest payments! I don’t know about you, but I can think of a bunch of things I’d rather do with $116,000 than pay it to a bank in added fees. You are going to pay a lot of money in interest regardless, but the difference in interest you would pay on a 30-year mortgage compared to a 15-year mortgage is HUGE.

 

Point 4: A 30-year mortgage has lower monthly payments

In case I’ve just convinced you to opt for a 15-year mortgage, let me remind you of one downside. In order to pay the loan in 15 years, you have to pay the bank a much higher monthly payment. Using the example from above of a 250,000 home with a $25,000 down payment and a $225,000 loan, the payments on a 15-year mortgage at 3.75% interest are $1,919 per month.  The monthly payments on a 30-year mortgage at 4.5% interest is $1,423 per month, which means you pay almost $500 less each month. For many people, that difference of $500 is huge. They may want to take that $500 and put it into their 401K retirement account. Or, they may want use that $500 to pay back student loans, credit card bills, or other high credit card interest debt.

 

Point 5: There are other ways to save money in interest if you opt for a 30 year mortgage

Keep in mind that if you decide to get a longer mortgage term initially, all is not lost. The interest you pay on your mortgage over time will be higher, but there are ways to combat this. You can: 1) pay more than the required payment each month on your mortgage (if there is no prepayment penalty), 2) send in extra monthly payments each year, or 3) refinance your mortgage to a shorter term after a few years to lower the interest rate.

 

To Summarize, if you’re a real estate investor, you may want to opt for a 30-year mortgage. This will lower your monthly payments and increase your monthly cash flow. If you’re buying the home to live in yourself, it depends.

·      You may want to opt for a 15-year mortgage if you are established in your career with a steady salary and can afford the higher monthly payment.

·      You may want to opt for a 30-year mortgage if you would rather have lower monthly payments (at the expense of a higher interest rate) in order to pay off high-interest rate debt (credit cards and student loans) or fully maximize the employer match of 401K retirement accounts (if you have one).

If you decide to opt for a longer mortgage term now, you may be able to pay off the loan faster in other ways (i.e. by sending in extra payments, paying more than the minimum each month, or refinancing later).

5 Things To Do Before You Buy A Home

As a young professional, one of your biggest decisions is whether you should buy a home or keep renting. After thoroughly considering the pros and cons of buying a residential home, you might have decided that buying a house is the ideal choice for you. Before you start the home-buying process, here are 5 things you must do before you purchase a home:  

1.Get an official copy of your credit report. Your credit report plays a big role in whether you can purchase a home. It determines the interest rate on your mortgage and can even be used to estimate how much money the bank will loan you to buy a home. Your job as a [future] homeowner is to get an official copy of your credit report from all 3 of the major companies that compute it (Experian, TransUnion and Equifax). You need to make sure there aren’t any false charges, incorrect debt amounts, or fraudulent claims on your credit report that are negatively impacting your credit score. Once you see your actual credit score, you’ll be able to estimate the interest rate on the mortgage and determine your monthly payments on different loan amounts.

2. Learn some basics about the local housing market. You will have a better chance of finding your ideal home if you gather some preliminary information about the housing market first. Go onto real estate websites like Zillow.com and get an idea of housing prices in your desired area. Look at recent selling prices, especially in certain desirable neighborhoods. You should also search for new developments and the construction of new homes.  Your real estate agent may have a few places in mind, but it is helpful if you have an idea of the housing market for yourself, doing so will give you a more realistic idea of what’s available within your price range and desired area.

3. Get prequalified for a mortgage. Unlike a pre-approval, a pre-qualification is a non-binding estimate from the bank of how much money they will lend you to purchase a home. This is important because unless you have $250,000 sitting in a bank, you are going to need a loan to buy a house. Getting an idea of how much money you have access to will determine the size and location of the houses you consider buying. It will also help guide your real estate agent since it gives them a more accurate budget to use during the search.

Keep in mind that the amount you are prequalified for is not guaranteed. The bank could decide to give you slightly more or slightly less a few weeks later. If you’d like a binding amount, you can get “pre-approved” for a mortgage. Pre-approval is different from pre-qualification because it is a guarantee from the bank that they will loan you a set amount of money at a set interest rate. The loan amount and rate are usually “locked-in” for around 60 days.  

4. Determine your estimated costs. Just because a bank is willing to lend you a large amount of money, doesn’t necessarily mean you should take all that money. You need to come up with a preliminary mortgage amount and determine what your monthly payments would be, factoring in the average interest rate. You should also determine the difference between what you [and your partner] pay now in rent and what you [and your partner’s] homeownership costs would be. You can do this by using a mortgage calculator.

Simply enter the loan amount you will need, the interest rate estimate from the bank, and the term length (15, 20, 25, or 30-year mortgage). Doing this will allow you to see your monthly mortgage payment. Then, you’ll want to add an additional 40% to that number (so multiply your monthly mortgage payment by 1.40) to account for property taxes, homeowners’ insurance, and repairs to get an estimate of what your total monthly homeownership costs would be. If that number is higher than you [and your partner] can afford, then reset the mortgage calculator and type in a lower loan amount. Using this tool will give you a better idea of your true price range, which is oftentimes lower than the amount the bank may have given you during the pre-qualification.   


5. Write down the highest amount you are willing to spend. Shopping for homes can be a stressful process. You may fall in love with one home only to find out later it’s out of your budget. You may also find yourself in a bidding war with another buyer or with a seller who refuses to negotiate the price. Both of these situations can tempt you to pay more than you can afford for a home. In order to prevent this from happening, be diligent. Come up with a price range and write down the highest amount you are willing to spend.

Although you may have gotten prequalified for a certain loan from the bank, it’s important to come up with your own price range, within reason. Be certain that the real estate agent does not show you houses above that price. This may seem a bit obvious, but real estate agents show potential buyers houses out of their ideal price range more often than you think because the agents are paid on commission. The more expensive the home the more money they make in return. Some agents may also want to see you happy in a really nice home, but the money they make as commission is a very powerful incentive. Write down your set price and stick to it.

To summarize, there are 5 things you should do before you buy a home. Follow the steps above as you start the home-buying process.