Family Traditions Can Cost You

Posted: May 08, 2013 12:01 AM

As I begin to navigate through the mortgage market once again, I feel that half of the craziness in this aspect of finance is because a majority of the industry is built on family tradition. For example, if Grandpa Bill had a 30 year loan, it certainly isn't my place to break the chain of our family by taking a 15 year loan. I will have no relative of mine spinning in their grave over such foolishness of changing the way we pay our home mortgage. Besides it really doesn't matter.

Here are a few facts that you should consider before making your decision:

FACT:  The 15 year loan has now reached 2.5% with a small origination charge. At that rate it will amortize 1/2 the loan in 8 years and finish the entire loan in 7 more years by simply making the payments.

FACT:  If the 20 year loan was at 2.5%, which it isn't, it would take 11 years to payoff 1/2 of the loan and 9 more years to finish.

FACT:  If the 30 year was at 2.5%, which it isn't, it would take 17.5 years to pay off half of the loan and 12.5 years to finish it after the 17.5 years.

 And it really doesn't matter!

Paying your loan as a bi-weekly loan (every 2 weeks) allows you to pay it down in approximately 24 years. A simply case of addition will show you that bi-weekly is 26 half payments or 13 whole payments. If you took the 13th payment and made it at the beginning of each year the mortgage balance would go down at that point and every payment after that would yield a little better amount of amortization. Bi-weekly pays the extra payment over the entire year and doesn't do as well.

Taking cash out of your house is not a taxable event. But, it could cause you to lose part of your new mortgage interest deduction as you cannot deduct anything over your current loan plus $100,000 if the money is used to improve the house. 

Back to the 30 year versus a 15 year. The 30 year is a point higher than the 15 year, which should make anyone stop and think about this: 1% more on a 30 year fixed has got to be a lot of money. ($185,000 on a 3.5% $300,000 mortgage). How much more could it be than a 15 year? Three times more:

$300,000, 15 year at 2.5% is $60,000 in interest over the life of the loan.

The real tragedy is the borrowers who take the 30 year and save $650 a month fail to invest it, for the most part. If they just stuck it the savings in a mattress in 30 years they would have $234,000. I haven't seen this happen or anything even close to it. The savings, as it turns out, is their road map to enlarging their living. There is nothing wrong with that approach if they have other means for reserves and retirement.

When you purchase a property for cash, up until recently you could not refinance the property and take the cash out for at least six months. Now you can, but the value of the property cannot be more than the purchase price and you have to prove that the money you bought it with was your own funds, not borrowed monies.

Finally, a 30 year loan is always the longest loan you can take. It also has the highest interest rate, the slowest amortization, the leader of the pack when rates rise (the follower of the pact when they fall) and of course second in line as the lowest monthly payment, behind interest only loans.

It is BY FAR the most popular loan in America and I can only ask,  Y?