Your Mortgage : Cost Argues Against Shift to 15-Year Loan

QUESTION: I bought my first home in November of 1988 and received an 8.75% FHA 30-year loan. This is a small condominium unit. I am 45 years old, and will need to work at least 15 more years in order to be eligible for retirement.

For some time I have been wondering if I should consider getting a 15-year mortgage, as I do not want to be burdened with a mortgage in addition to condominium fees.

Assessing how and when to consider such a change is confusing to me, and I would appreciate your advice on the advantages and disadvantages of the 15-year versus the 30-year mortgage.

ANSWER: You have asked two very important questions. One deals with the two mortgages, but the second one--equally important--goes to the question of when and whether to refinance.

Let’s take the refinance question first. You indicate that you have an 8.75% FHA loan, which you took out in 1988. To switch to either a 15- or 30-year new loan means you will have to refinance. Before you even consider switching mortgage loans, go out and take a look at the interest rates currently available in the marketplace.

Unless you want to take a one-year adjustable rate, I doubt that you will find a 30-year loan--or even a 15-year loan--for the same rate that you are now paying.

And do not forget that you will have to pay points and other closing costs for your new mortgage. Each point is 1% of the loan amount, and if you were to refinance for $100,000, I suspect that you would probably pay somewhere between two and three points--or in other words $2,000 to $3,000--to refinance.

Thus, under current market conditions, I do not believe that you should even consider refinancing. The general rule of thumb is that until rates come down at least two full percentage points below your current mortgage, it does not make sense to refinance.

As to advantages and disadvantages of a 15-year loan as compared to a 30-year loan, I must state that I am biased against the 15-year loan. While there have been many commentators who have praised what they perceived to be the benefits of a 15-year mortgage, in my opinion such a mortgage rarely makes sense for the average homeowner.

Let’s look at some examples. You want to compare a $100,000 loan amortized on a 30-year basis to one amortized on a 15-year basis. While there are lenders who may give you a slightly lower interest rate if you take a 15-year loan rather than the 30-year, for comparison purposes let us assume the loans will cost 9%.

To amortize the loan over 15 years, your monthly payment of principal and interest is $1,014.27. On a 30-year basis, the P&I; is $804.63. There is a $209.64 cash saving per month on a 30-year loan. On a yearly basis, this is a saving to you of $2,515.68.

Keep in mind that the interest deductions for tax purposes will, by and large, be the same for the first few years, but as your principal balance goes down faster with the 15-year amortization, accordingly your interest payments will also be smaller.

Thus, the major benefit of the 15-year loan is that you will save a lot of interest over the life of your mortgage. You are also putting up, in your example, over $2,500 a year toward principal, thereby reducing your mortgage balance and building up your equity.

Equity is the difference between the market value of your house and the mortgage or mortgages which you owe. In good real estate market conditions, property values increase on a yearly basis as much as 10% to 15%. Even in bad times, we all hope that property values will at least keep up with inflation, although obviously there will be dips and decreases in market values on a periodic basis.

But assuming that we anticipate growth over the next decade, the equity in your house will grow regardless of the amount of your mortgage. This equity is “dead equity” and in my opinion, you might as well be taking that extra $2,500 and burying it in your back yard.

I would rather take the extra $2,500 a year and invest it somewhere. I could put it in a pension plan, I could invest it in the stock market, I could give it to my children, or I could spend it on a vacation with my family.

After all, what will you do with your house 15 years from now when your mortgage is paid in full? I know of too many people who are currently house rich and cash poor. When you are in retirement, you may not keep that house, or if you do, you want to make sure that you also have some sort of nest egg to be able to enjoy your retirement years. If you have put all of your money into your house, and then you retire, you may not be in the financial position to tap into the equity at that later date.

This advice is obviously general. Please discuss your specific needs, plans and tax considerations with your own advisers.

Average Rates for Residential Mortgages

Average rates for residential mortgages as of Sept. 20, 1991.

Survey Conventional Mortgages Adjustable Mortgages Area 15 Year 30 Year Composite 1 Year Composite National 8.73% 9.05% 8.90% 6.81% 7.12% California 8.88 9.17 9.03 6.85 6.91 Connecticut 8.74 9.05 8.93 6.85 7.12 Wash. D.C. 8.59 8.91 8.77 6.63 7.08 Florida 8.68 9.01 8.86 6.75 7.06 Mass. 8.68 9.00 8.85 6.72 7.24 New Jersey 8.74 9.05 8.91 6.77 7.28 N.Y. Metro 8.79 9.11 8.97 6.84 7.22 New York 8.85 9.18 9.03 6.89 7.18 N.Y. Co-ops 8.99 9.31 9.24 7.42 7.80 Pa. 8.51 8.90 8.71 6.67 6.91 Texas 8.63 8.97 8.81 6.70 6.93

SOURCE: HSH Associates, Butler, N.J.