Last we week, my wife and I agreed to buy a house. From a financial perspective one of the biggest questions when buying a house is, "What do we do about a mortgage?" Most people who haven't bought a home, don't know much about mortgages. It's not the kind of thing they teach you in high school. Of course this lead to a problem a few years back of people getting into mortgages that they couldn't afford. I'm going to take a risk that most of the readers here have a basic understanding of mortgages.
So when I asked myself the question of what am I going to do about getting a mortgage, I thought the answer was going to be easy. Turns out it is a little more tricky than I thought. The first course of action was to decide between a fixed mortgage and an adjustable mortgage. I didn't even spend 0.00002 miliseconds thinking about an adjustable mortage. With the interest rates nowadays it doesn't seem to make much sense to risk that they'll go up in the future. I called several lenders in the local area of the house and looked on the internet to get an idea of what rates we could expect. To get an idea, the lenders ask you are few questions... mostly about your income, debts, and credit history.
My wife thanked me for insisting that we keep track of our net worth every couple of months. It made answering these questions every easy. In addition the ability to get free credit scores came in handy as well. After providing that information to several lenders, each one came back with just about the same rates: 4.5% for a 30-year fixed, 3.75% for a 15-year fixed.
This is where I'm a little perplexed. We have the income for the payments either way. We also have a healthy emergency fund that can carry us through over 18 months either way. With that out of the way, it seems like it comes down to paying 4.5% vs. 3.75% in interest. It is better to pay 3.75% in interest, right? Well, I'm not so sure. There's the opportunity cost to consider. If we were to go with the 30-year fixed mortgage, I would have more money each month to invest. Is that investment more likely to grow faster than the interest that I'm paying? It seems like history tells us it would. However, a lot of my investments in the last ten years haven't grown as history has suggested it would.
One lender had a calculator tool to do a little math. He did the math on how much interest we'd pay over the life of the loan under a few scenarios. In the case of the 15-year fixed at 3.75%, we'd pay around $99,000 in interest. If we did the 30-year fixed at 4.5%, but made the same payments as the 15-year fixed requires in an effort to pay it off early, we'd pay around $130,000 in interest. Finally under the scenario of doing the 30-year fixed and making all the minimum payments, we'd pay around $263,000 in interest. I found a similar calculator at Bankrate.com.
These scenarios greatly make me lean towards getting the 15-year fixed at 3.75%. However, the opportunity cost of investing would likely mathematically mean otherwise.
Readers, here is where you come in. What would you do?
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