With today's low interest rates, does it make sense to build equity fast or try to pay off a mortgage?Is it better to sign for a longer term and then pay additional principal each month? What is the best strategy for building a secure future?
Burning the Mortgage -- An Outdated Goal?
There was a time, not so terribly long ago, when the goal of every homeowner was to have a "burn the mortgage" celebration. But that was when buying a home seemed more like an end goal than home ownership is today. That was also during a time when having the security of a home for old age and future generations was simply "what was done."
Today, owning a home "free and clear," is almost a negative, because it requires cash reserves for taxes and insurance, even though it is possible to borrow against the equity.
Pros and Cons of Short and Long Term Mortgages
Because there are many financing options available, each borrower must assess the situation on individual terms. Depending on your income and individual goals, either of these options may be more viable to you.
Pros and Cons of Long Term Mortgages
One of the most compelling reasons buyers have for choosing a long-term mortgage is the smaller, affordable monthly payment amount. Because of the lower payments, many buyers can choose a more expensive home without having to begin with a "starter home," and then move up when more space is necessary. Long term mortgages do come with more interest over the term of the loan, but mortgage interest is currently tax-deductible and that will ease the burden.
Long-term mortgages do tend to have higher interest rates as they are a little riskier for lenders. It also takes considerably longer to build equity in your home. Smaller payments and greater interest burden only leave a small amount going toward paying off the principal in the first several years.
Pros and Cons of Short Term Mortgages
The main advantage of a short-term mortgage is the ability to pay off the loan faster. Not only will larger payments eat away at the principal more quickly, but the lower overall interest burden means less to pay in the long run. That brings us to the next advantage: the total amount of cash you'll pay for the home will be significantly less.
The higher payment amounts can make it difficult to focus on other goals, such as saving for retirement or upgrades around the home. It can also be tricky to keep up with the larger payments when unexpected events such as illness or job loss occur. Rapidly paying down the mortgage also means that more of your cash will be tied up in the equity of your home and can only be accessed by selling or by borrowing against it with a home equity loan.
When Do You Plan To Move Again?
In 2013, a study commissioned by the National Association of Home Builders found that the typical American planned to stay in a home for only about 13 years. "Mobility statistics" are somewhat inconclusive at best and may be misleading, but there is no doubt that current generations of home buyers are less attached to their "sticks and bricks" than pervious buyers were.
The U.S. Census Bureau confirms that the average American moves 11.7 times, whether for job reasons or for purposes of "moving up" and "scaling down." More recent statistics point to the average American moving out and moving on every six to nine years.
So, when it comes to choosing a standard 30-year mortgage or a currently-popular 15-year payout, what makes the most sense for today's buyer?
Effect of the Housing Crisis
When interest rates were higher, it was clear that regularly paying additional principal could save a substantial sum of money. At the same time, some of those people who paid off mortgages during the height of their earning years suffered from not having hefty mortgage interest deductions to counteract income tax obligations.
Interestingly, when the housing crisis hit and foreclosures loomed, interest in shorter term mortgages increased because of spreading foreclosure fears. Some of that nervousness still exists in terms of housing commitments; home ownership percentages are currently lower nationally than they have been for almost 50 years, with many young people opting to rent rather than buy.
However, even with interest rates still low, high wage earners appreciate the mortgage interest deduction; it can have a substantial effect on federal and state income tax obligations. Shortening the term of the loan would, in effect, eliminate that tax advantage faster.
Securing Your Financial Future
The bottom line is that you have to assess your own situation thoroughly before making a mortgage decision. There are options other than 15 and 30-year fixed-rate loans and, when it comes to planning your financial future, it is wise to explore all possibilities to make the decision that best meshes with your personal needs and goals. #hw
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