I’m not sure if you noticed, but it’s election season. And while the title of this week’s show is “Term Limits,” it fortunately has nothing to do with politics. Rather, it’s a continuation of various themes we have discussed on prior shows—namely, how to use your knowledge of coming economic trends to structure your finances and how to use smarter mortgage products to come out ahead once those trends subside.
I have said repeatedly (but not too forcefully, since I have to make a living!) that the 30-year mortgage is the biggest government-sponsored scam around. Even loans financed with today’s historically low rates will, once amortized over 30 years, cost double the principal amount because of interest. As an exercise, look up a mortgage calculator online (most banks and lenders have one on their site) and compare the same principal amount at 4.5% amortized over 15 and then 30 years. Then consider that 4.5% rate you’re will probably increase over the next couple years. The difference in interest will shock most people.
This is, in essence, what I meant by ‘term limits.’ The terms of different mortgage products will have different limits. It’s crucial to familiarize yourself with those limits and decide which best suits your financial needs. While most will agree that a 30-year mortgage is easier to carry—that’s why they exist—they should ultimately understand that a 15-year mortgage is, in fact, better.
To understand why, recall what I have said on past shows about the anticipated trajectory of the US economy over the next several years. Those of us who subscribe to a demographics-based view of economics believe we are in for another six years of poor economic performance before things start accelerating in the year 2020, when Millennials begin reaching their peak productive years. This leaves six years of spinning our wheels and probably another five or six years before the economy really takes off.
Where will you be in 10 to 15 years, and where will your friends and neighbors be? If you have a 15 year mortgage and they have a 30-year mortgage, here’s where you’ll be: 15 years ahead of your neighbor. You’ll own an asset outright while they’re still paying on theirs. You’ll have more resources to invest and save. You’ll also be tens of thousands, if not hundreds of thousands, of dollars ahead because of the money you saved on interest.
Now, where will you be over the next 10 to 15 years? If you opt for a 15-year mortgage, you’ll have a few hundred dollars less to spend each month. Your house will probably be slightly smaller than you could have afforded with a 30-year mortgage. There are costs—sometimes painful costs—associated with more prudent loan options, but ultimately you will be far better off than if you’d chosen the alternative.
If you’re more concerned with instant gratification than long-term planning, then by all means choose the easier program. But if a few extra hundred dollars a month is worth the tens of thousands saved over the life of the loan, you should absolutely choose the shorter term. You’ll not only be far better off in the future, but you’ll likely make a smarter home purchase. Spending less makes you more conscious of value, and rather than buying whatever you want, you’ll be forced to buy what you need. That is one limit of a 15 year term, but sometimes limits coax us into doing what we should have done anyway.
10-25-2014 Term Limits