Why are you in such a hurry to pay off your mortgage? We should take a lesson from the tale of the tortoise and the hare when it comes to home loans. Slow and steady wins the financial race.
So let’s get back to our study of the truth about home mortgages after a brief detour to dissect Bret Arends’ Wall Street Journal pro home buying article. Previously I explained Common Mortgage Belief #1: I’ll be more financially secure the sooner I pay off my mortgage. Today we’ll look at a related misconception about mortgages.
Common Mortgage Belief #2: I want the 15-year mortgage because my loan will get paid off earlier.
Uncommon sense: A 30-year mortgage in most cases gives you the ability to prepay when you choose. By making extra principal payments each month you can create a synthetic 15-year mortgage. It is true that the interest rate on a 30-year mortgage is higher for two reasons. You are paying a default risk premium to the bank for the extra 15 years of scheduled principal repayment. The longer repayment period increases the odds that a life event will happen that makes you unable to repay the loan. You can also look at part of the higher rate as an insurance premium in case your personal financial situation changes due to job loss or medical emergency for example. If you suffer an adverse cash flow life event, you can return to the normal 30-year amortization schedule instead of the optional 15-year payment plan. If you choose to make extra principal payments, you missed my earlier post that showed why prepaying your mortgage is not the best use of free cash.
Dictionary.com defines insurance as any means of guaranteeing against loss or harm. A 30-year fixed rate mortgage has a guaranteed payment that will always be an option if you can no longer make extra principal payments. You are insuring against the loss by foreclosure if you can no longer make the synthetic 15-year mortgage payment.
Slow and steady wins the mortgage race. The 30-year fixed rate mortgage has several advantages over other forms of home loans including lower shelter consumption costs through lower monthly mortgage payments. If shells were financeable dwellings, I’m sure the wise tortoise would have chosen a 30-year fixed rate mortgage.