Interest Payments
Sunday, November 25th, 2007Does a longer term loan really save you much on your monthly payment?
The payment on a $165,000 30 year mortgage at 7% is $1097.75. The following file is the amortization table.
As you can see, you pay over $230,000 in interest over the life of the loan.
The payment on a $165,000 20 year mortgage at 6% is $1182.11. The following file is the amortization table.
This time you are only paying $118,000 in interest over the life of the loan.
By agreeing to a shorter loan, the bank will allow a better fixed rate. You can see that the difference in payment is less than 100 bucks a month. Your house is paid off in 20 years instead of 30. A one point decrease in rate may not seem like much, but it is huge.
More examples.
How about a $250,000 loan?
30 years at 7% is $1663.26 a month paying $348,000 in interest.
20 years at 6% is $1791.08 a month paying $179,000 in interest.
By increasing your payment only $128 a month, you save around $170,000 over the life of the loan. You build equity in the house much quicker. Using the shorter, lower interest loan, in 10 years the balance on the loan will be $160,000. If you have the longer term, higher interest loan, the balance in 10 years is $214,000. Regardless of the value of your house in ten years, you have much less equity. If you needed to refinance for any reason or sell the house, you lose over $50,000.
So what if you have the same $250,000 loan at 7% and you simply decide to pay more than the minimum payment? Let’s pretend you pay the extra $128 a month. The total interest is $268,000 and the loan is paid off only 5 years sooner. In ten years, your balance is still $191,000, which means you are still down about $30,000 in equity compared to the 20 year loan.
You will note that I am showing fixed rate examples. You may be curious as to why I’m not discussing interest only or adjustable rate mortgages. If you see what these loans have done to the credit market, you probably understand. I don’t believe you should buy a house not knowing what your future interest rate may be. The current economic situation of the entire planet is my reason.
If you are trying to buy a house right now, make sure your lender shows you options that include lower rates for shorter terms. They should be able to offer you lower rates if you look at 20 years instead of 30. As you can see, even a one point difference means quite a bit of money. This will save you thousands and will allow you more room during rough patches.
I’m working on financing for real estate right now so I did some research. I will be writing some more about this in the near future. If you are looking into real estate investing, this may be of interest to you. If your plan is to buy property to rent while you wait for home prices to increase, a lower rate can mean hundreds of thousands of dollars to you.
