I'm Not Kidding: A 30 Year Fixed is "OK"

Posted: Jul 18, 2013 12:01 AM

People believe that I find the 30 year fixed loan to be the devil's work and not fit for humans to consider as a financial vehicle.  Nothing is farther from the truth, HOWEVER, there are only 3 situations that I think make sense as a loan:

1.  If you can't qualify for any other loan.

2.  You have a rental(s) and you want to maximize your cash flow

3.  You use all of your cash to make your living.

Let's take a look at these three instances. If you can't qualify for any other loan it should be a red flag for you when buying a house.  Not being able to qualify can mean less than stellar credit, earnings that are almost too small or a deficiency in liquid assets: cash, stocks and bonds, notes etc.  The biggest cash need when purchasing a house isn't usually the down payment. It generally comes as fix up money or repair money once you own the house and begin living there. 

I can tell you that most buyers are not prepared for these expenses and their financial condition begins to worsen from the beginning of the occupancy.  Not having a cohesive financial plan makes it very hard to turn things around. It also can affect your relationship with your spouse and that is an even bigger problem. Having a 30 year loan might help with keeping the mortgage payment lower, but it will not help you build equity. In our low interest rate environment a 30 year payment will only amortize 9% of the loan in the first five years, while a 15 year will amortize 28% of the loan in the same time frame. Can you really ignore these figures?

Plan before you act and all of the above is moot!

For those who want greater cash flow in their current rentals, or the one(s) they are purchasing now, the clear choice would be a 30 year amortization but not necessarily a 30 year fixed.  A 5 year or 7 year arm might be a point lower and make a significant difference in payments and amortization

Those who use their money to make a living as the hedge fund managers, the professional stock market traders, commodity traders, etc a 30 year fixed may seem like an excellent long term fix, but it really is too expensive. Major traders have used loans tied to short term treasuries or foreign securities even though the interest rate is fixed for a very short time and can change monthly or yearly. They realize, however, their actions can save them several points in interest which could make a huge difference in their earnings potential. If the market turns up quickly they can always get out of their positions and pay the loan off. 

In looking at the pluses and minuses of the 30 year loan about 20% of the borrowers at most are candidates for the loan; unfortunately the loan is used by the inverse of that number: 80% of all mortgage holders.  If you truly care about your future you need to examine all facets of the 30 year loan and see if it is a benefit to your long term success or a detriment.

A mortgage professional can suggest many different approaches but it is up to you to take the one that fits your situation, not theirs.  I still would rather see you take a 5,7, or 10 year arm, if they are priced better than  a 30 year fixed, and maximize your payment.  Maximizing your mortgage means either paying your new arm with the same amount you would have had to pay on the 30 year because it was at a higher interest rate and payment.  The result would be a faster amortization and by the time you are through with the fixed rate of your arm you will owe much less on your loan than you would have if you had taken a 30 year fixed.

Remember the goal of a mortgage is to help you own a house, the sooner the better.