Shorter-Term Mortgages Make Sense for Some
Should you shorten the term of your mortgage?
Today's low rates have millions of homeowners rushing to refinance. However, a large number of mortgage owners in the U.S. are switching from the old industry standard of 30-year fixed-rate loans to those that must be paid off in 15 or 20 years, said
Lazerson estimates that between 40 percent and 50 percent of his customers have been choosing shorter-term loans in recent months.
The shorter-term loans can save a half-percentage point in interest charges. And repaying sooner means you pay less interest over time.
The downside? You obligate yourself to a higher monthly payment. And even if you can afford that, there may be better ways to invest your cash.
"The long-term benefits of a shorter-term mortgage are real," said
Let's take a look at the options, using two hypothetical consumers -- Suzie Secure and
In today's market, they could secure 30-year fixed-rate mortgages at about 4.5 percent or 15-year loans at about 4 percent.
Suzie Secure chooses the lower-rate 15-year mortgage, which comes with a monthly payment of
Secure pays off her loan after 180 monthly payments, for a total cost of
So is Secure better off? That depends on what Chance does with his monthly savings. If he invests that money regularly and is able to earn more than 4.5 percent in interest, he'd be comparatively better off.
Let's say, for example, that Chance invested in a diversified portfolio of big company stocks, which has earned an average of about 9.6 percent over the 83-year period tracked by
Assuming he got that average return, Chance would end up with a nest egg worth
Of course stock returns are anything but guaranteed, as the last "lost decade" so vividly illustrates. If Chance wanted to take a somewhat safer course, he could put the money in a portfolio made up of 50 percent stocks and 50 percent bonds, which has been considerably less volatile than portfolios made up of stocks alone. Historically, this investment mix produces long-term returns of 8.2 percent, according to Ibbotson. That would leave Chance with
What about taxes? Chance will pay less federal income tax over the life of his loan because he can write off mortgage interest -- and he's paying more of it than Secure -- but he'd owe tax on his investments when they are sold. For purposes of this example, we've assumed that this combination makes the tax issue a wash.
The catch is that stock market returns are not guaranteed. So where Chance might end up with a windfall, he also might end up with less. In today's market, there are no guaranteed investments that earn more than 4.5 percent.
That said, the odds of earning more than 4.5 percent on long-term money are in Chance's favor. There have only been a handful of 10-year periods when average stock market returns have been negative -- two of them during the Great Depression and the rest during this last decade.
Investors have a tendency to believe that whatever happened most recently is most likely to happen in the future, but Ibbotson data refute that notion. If you look at decade-by-decade returns, bad decades were often followed by blockbuster decades; good decades -- such as the 1980s and 1990s -- were followed by this miserable decade, which was the worst in recorded history.
Though no one knows when markets might turn, the chance of stocks earning more than 4.5 percent on average over a long stretch is good, history tells us.
But, Gumbinger said, there's another risk. Namely, Chance might not be disciplined enough to invest his savings. If he's not, he ends up paying more with the longer-term loan and has nothing but depreciating consumer products to show for it.
"Too many of us, when we have an extra
Available at Amazon.com:
- How Work Impacts Social Security Benefits
- Raising Retirement Age Will Help Save Social Security
- Cutting Benefits Isn't the Way to Save Social Security
- Baby Boomers Will Redefine Retirement on Own Terms
- Retirement Planning: Taking Stock and Coming Up Short
- Don't Procrastinate on Wills and Estate Planning
- Annuities Can Be Valuable Slice of Retirement Funding Pie
- Videos Put Entertaining Spin on Money Management
- Shorter-Term Mortgages Make Sense for Some
- SIPC Considers Revamping Rules
- Expect Significant Changes During Open Enrollment for 2011 Health Coverage
- Patients Beware: Hospitals Increasing Requiring Cash Up Front
- How the New Consumer Bureau Will Help You
- Looking for Overseas Retirement
- Do You Live in a High-Debt City?
- 10 Historic Places to Retire
- Don't Get Caught in Sticky Web of Credit Card & Bank Fees
- The New Retirement Plan: Watch the Expense Side of the Equation
- Recession Prompts More Americans to Tap Retirement Security to Make Ends Meet
- Preventive Care & Electronic Medical Records Guidelines Set
- 5 Retirement Myths
- How to Tell if You Have a Good 401k Plan
- Insurance for Boomerang Kids
- Boomers Take On 'Necessities' May Not Be Grounded in Reality
- Avoid IRA Tax Pitfalls
- New Rules Slash Credit Card Fees
- More Consumer Protections on Bank Overdrafts May Be Coming
- Most Okay With Higher Social Security Taxes
- How to Retire Gradually
- Plan Ahead For a Comfortable & Potentially Rich Retirement
- To Understand Your 401K Plan Just Focus on the Fees
- Buying Coupons for Deep Discounts Carries Risk
- How New FTC Rules for Debt-Settlement Firms May Protect You
- 529 College Plans Not Completely Trouble-Free
- New Website Helps You Navigate Health Insurance
- Prepare For the Rising Cost of Long-Term Care
- How Much Life Insurance Do You Need?
- The Great College Scholarship Scramble
- The New High-Risk Health Insurance Pool: Common Questions
- Misunderstandings Rampant on Health Care Reform & Medicare
- How to Talk to Your Parents About the Estate Tax
- Should Young People See a Financial Planner?
- 10 Ways to Ruin Your Retirement
- Understanding the Psychology of Retirement Planning
- Five-Year Rule for Roth IRA Withdrawals: A Primer
- Hard Times Triggering Spike in Consumer Fraud
- New Sites Empower Students to Build Their Own Scholarships
- 10 Things You Didn't Know About Social Security
- Costly 'Add-On' Insurance More About Profits Than Benefits
- Teaching Your Child Money Habits for Life
- Retirement Living Decisions Don't Require Hand-Wringing
- Sears Brings Back the Christmas Club
- Will You Run Out of Money Before You Run Out of Years?
- Best and Worst Places to Build a Nest Egg
- 21 Ways to Make Extra Money in Retirement
- Do You Trust Financial Services Companies? Trust Index Says Not So Much
- Don't Be Intimidated by Medicare Labyrinth of Letters
- 2010: Good Year to Die For Your Heirs' Sake
- The Dangers of DIY Estate Planning
- The Economy's Lasting Impact on Your Retirement
- Unconventional Retirement Investing Strategies
- Another Retirement Challenge for Women: Income Gender Gap
- Launching Your Own Business After Age 50
- Key Questions to Ask Before You Hire a Financial Adviser
- The New Good Life: Living Better Than Ever in an Age of Less
- 15 Ways to Tell if You Are Ready to Retire
- How to Maximize Your Social Security Benefits
- How Working Longer Helps Build Retirement Security
- How to Find a Low-Tax Place to Retire
- Investing Your Social Security Check? Consider These Factors
- Alternatives to Traditional Retirement
- Change On the Way for Retiree Health Benefit Programs
- Two New Medigap Plans to Consider
- Sizing Up Your Retirement Nest Egg Needs
- Biggest Sources of Retirement Income
- Assembling a Sturdy Retirement Portfolio
- Withdrawing from Retirement Accounts Early without Penalty
- Social Security Inflation Adjustment Debate
- Biggest Sources of Retirement Income
- Don't Neglect Long-Term Care in Retirement Planning
- How the Health Care Bill Impacts Retirees
- Jobs With the Best Retirement Benefits
Personal Finance - Shorter-Term Mortgages Make Sense for Some
(c) 2010 Kathy Kristof