So what is the answer? If you are just starting out, the answer is very easy. Do not follow the advice I was given, which was "buy as much house as you can afford with a 30-year loan". The new advice is: Buy as much house as you can with a 15-year loan, or worst case, a 20-year loan. The reality is that your first house will not be everything you want or even need, but every home after that will be. Why? Because you will have the equity from your first house to use to purchase a bigger house, or better house, and the discipline to continue using a 15 or 20 year loan. Let's look at the examples:
30-year loan
$300,000 house; $270,000 loan = $1600/month
5 year balance: $251,000
Amortization $ 19,000
15-year loan
$222,000 house; $200,000 loan= $1635
5 year balance: $151,500
Amortization $ 48,500
At this point I assume both buyers will move up. Neither house has appreciated, and the 30-year loan buyer will have $49,000 to use ($30,000 down payment on the first house plus the amortization), while the 15-year loan buyer will have $70,500 to use from the down payment and amortization. The gap would be closer in the first five years if there were some appreciation, as the $300,000 would have greater value than the $222,000 house. This would begin to reverse by the sixth or seventh year, as the amortization value would really start widening. Example:
30-year loan ($270,000)
7 year balance $241,000
10 year balance $225,000
15 year balance $191,000
15-year loan ($200,000)
7 year balance $128,000
10 year balance $ 87,000
15 year balance $ 0
At the end of 15 years, the 30-year buyer would have a value (without any appreciation of the house) of $109,000, which again is made up of his amortization and down payment. The 15-year buyer would have $222,000, which was the purchase price, as he will not have any loan.
Let's add in some appreciation to the value of the house, 2% annually, and the buyer with the 30-year loan will have an additional $90,000 in value for a total of $199,000 while the buyer with the 15 year loan will have an additional $66,000 for a total of $288,000.
I wish to emphasize that both buyers had the same approximate payment of principal and interest for the entire 15 years. It is pretty simple to see that starting out with the right loan and the discipline to “under buy” the house (take a house that you can afford on a shorter amortizing loan) for the sake of the loan is the way to go. But unfortunately most of us didn't get that message when we began, so what should we do now?
Those who have a 30-year loan or an arm that is amortized over 30 or more years and have debt can do what I have been proposing all year. You can roll all your debt into a new mortgage as long as you can either save money on a monthly basis (not the primary goal) or lower your amortization to a 20,15 or 10 year fixed and have a lower payment, or be able to do both and have the best of both worlds. If you study the ramifications of this you will see how much it makes sense and the hundreds of thousands of dollars you will not pay in mortgage payments (save).
Should you have a 30-year or longer mortgage and not have debt then it takes willpower or a burning desire to free up your life in the future to make the change. I usually will tell this type of borrower to cut back on the weekend spending and you will save enough to slip right into a 15-year or 20-year mortgage.
For those who are investment minded, take the difference between your current 30-year payment and a proposed 15-year payment and consider the difference an investment. Calculate the yield by figuring out your balance on your current loan in 15 years if you don't make the change, and now you have the cost (the difference between the two payments times 15 years) and the dollars you will not pay (save) which is the balance you determined you would have in 15 years. This should turn out to be pretty dramatic and make you want to move forward.
If this column does anything at all, it should show you what you are currently missing and what you can do about it. Depending on the numbers that you come up with, your motivation should be staring you in the face. Then, if you would like, add some appreciation and start looking for sacks to store the gold for the golden years.