Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

Had a debate with a co-worker today on a 20 year fixed vs a 30 year fixed mortgage. For simplicity, assume a rate of 6.125% on both and a $150k loan balance. What rate of return on your investment would be needed to outperform the 20 yr fixed after taxes at the 10 yr and 20 yr marks by investing the difference in P+I of the 20 yr and 30 yr? Is there a calculator for this somewhere? Any comments on the risks and such of doing this ?

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

1. Open Excel.
2. Figure out what tax rate you want to use.
3. Figure out what investment rate you want to use.
3. Spend 10 minutes playing with numbers to find out your answer.

The risks are that your tax rate won't be accurate over such a long period and your rate of return will be wrong for years 20-30.

Seriously, take some time and figure this out for yourself. It will get you thinking about investing more than somebody here giving you the answer. I know this post is not helpful, but you should use this as a learning exercise.

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

I was hoping someone knew of a calculator to save time.

Just did the excel thing and at 10% ROI the after tax gains of investing would still be $600 behind the 20 yr at yr 10 but is ~$20k ahead at year 20.

EDIT: At 8% ROI the 30 yr trails by $3k at 10 yrs and is $400 behind at yr 20.

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

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assume a rate of 6.125% on both and a $150k loan balance.

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This is a bad assumption.

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What rate of return on your investment would be needed to outperform the 20 yr fixed after taxes at the 10 yr and 20 yr marks by investing the difference in P+I of the 20 yr and 30 yr?

[/ QUOTE ]I'm not sure what you are asking. However, if you think you can earn better than the mortgage rate somewhere else, you would be better off with the 30-year because that gives you more money to earn that higher rate with than had you got the 20-year.

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

Why is my assumption bad? Don't just say that without saying why. There's is about $500 difference in closing costs to get the same rate on a 30 yr as I'm getting on my 20 yr.

The question I was asking was: if I take the difference between the mortgage payment on a 20 year and 30 year fixed and invest it, what is the required return to beat the advantage of using the shorter 20 year financing period?

Going the investment route takes too much risk and also extra time, effort, and discipline to follow through. 8% for 20 years in a row doesn't even break even. How do you think you can convince yourself you can get 9% ROI for 20 years in a row? If you're good maybe you can, but I recognize that I probably cannot.

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

Is this just a theoretical question? In the real world, why wouldn't you always take the 30 yr mortgage if the rates are the same? If you wanted to pay it off faster, you could. Since the 20yr rates don't offer an advantage over the 30yr rates, you have less risk to take the 30 yr loan, because your monthly payments will be lower should you need to make the monthly minimums (job loss, etc...).

Since after tax deductions your effective rate on your mortgage is going to be around 4.5%, wouldn't any investment that returns 6-7% outperform the 20yr fixed?

Max

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

Max,

I've always wondered this. If you have great credit (820+) could you not get a 30yr or 40yr in most cases with a rate very close to the 15yr allowling great flexibility if you wan to put payments on principle or worry about job loss, taking a cruise over Christmas, etc?

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

I'm closing on a condo on Tuesday, so it's not a theoretical question. I was thinking a $170 difference in payment (the actual true difference in my specific case) isn't really a big deal when the advantage is outright ownership in 10 years less time, and accelerated gain in equity. Basically, I'm thinking that $170/month difference isn't gonna break me. If I were to get in a position where I couldn't make the 20 year payment, I wouldn't be able to make the 30 year payment either.

Tax deductions are present on the 20 year as well as the 30 year so they cancel each other out, or are close enough to ignore IMO. The big difference is the amortization of the 20 year loan vs. the 30 year loan. It's not as simple as beating the interest rate.

If my thinking is flawed please give me advice. My long term plan is to live at this place for 7-9 years and then keep it as a rental property (excellent location) afterwards.

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

You can pay off a mortgage earlier that it says to.

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

Yes, that was my point exactly. The only real reason to take the shorter loan is to gain an advantage with interest rates. If the rates are the same, then get the longer term loan, and just make extra payments to principal if you want.
$170/mon = $2000/year and would be better placed in an IRA rather than paying the house off earlier, if you are not yet contributing to an IRA.

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

It doesn't work like that. If I paid the difference ($170) into principal on the 30 year fixed every month, at the end of year 20 I would still owe ~$40k on the loan, where as the balance is paid in full on the 20 year mortgage option. Yet in both cases I paid the same amount.

You have to look past the interest rate to the amortization table. If you finance a car at 5% for 5 years you will always pay more than if you financed it for 5% for 1 year.

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

Umm... I thought when you made a payment toward principle... It went toward principle...

Can you explain?

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

30 year fixed @ 6.125% = $911/month payment

20 year fixed @ 6.125% = $1085/month payment

difference = $174/month

At the end of year 20, the 20 year fixed is paid for free and clear, but the principle balance on the 30 year fixed is
$81,630 (not even half the loan has been paid back). Take $174*240months=$41,760.

So even contributing the difference to principle you've paid the same thing but still owe ~$40k because of the way the loan amoritizes.

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

http://www.bankrate.com/brm/mortgage-cal...rtization+Table


Try using that. I probably should just googled for it initially. I can't think of a circumstance where getting a longer loan and applying extra payments to princeple results in a longer loan. In fact in the example I did. You end paying it off the exact same month while giving youself greater financial flexibility.


Prepayment penalties are a concern and something that must be looked into.

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

There's something I don't understand here. So the additional payments are affecting the amortization I guess? Maybe I am wrong, I don't think I can change it though since my closing is Tuesday. Oh well.

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

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There's something I don't understand here. So the additional payments are affecting the amortization I guess? Maybe I am wrong, I don't think I can change it though since my closing is Tuesday. Oh well.

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Yeah you pay down the amount you are borrowing. They don't charge you full interest for the initial amount if you apply payments to principle. This is something I'm gonna look to in the future as I'd like to pay off my first place to then use as rental property. Ideally I want a very long mortgage with no prepayment penalty and a very low rate (sweet pipe dream). Since my income isn't very stable I can tack a few thou on when I need to and can leave it off when I don't.

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

You are not figuring in the 6.125% per year interest that you are saving by paying down the principle each month. The way you figured it, you would just be applying the $41,760 extra payment at the end of year 20, not throughout the life of the loan.

IF you were to put the $174 every month into some sort of investment vehicle that was paying 6.125% return, and apply that at the end of year 20, you would surely have more than $41K. Paying the interst early will have the same net effect. This is why you should invest the money into something besides paying down your mortgage if you can beat the rate of the mortage as an average rate of return.

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

I know there is no prepayment penalty on my 20 year fixed, so I'd imagine the 30 year is the same. Thanks for the link Thremp.

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

But therein lies the trick right? You must be paying down the principal the entire time anyway to see the advantage. If the money is spent investing, then the loan continues to amoritize at the 30 year rate and you will still owe the $81k principle at the end of year 20. Your investment will have to do about 9% ROI each year to beat the 20 year after you figure in the capital gains tax.

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

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But therein lies the trick right? You must be paying down the principal the entire time anyway to see the advantage. If the money is spent investing, then the loan continues to amoritize at the 30 year rate and you will still owe the $81k principle at the end of year 20. Your investment will have to do about 9% ROI each year to beat the 20 year after you figure in the capital gains tax.

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Yeah, most people do it for the versatility IIRC. Though I don't talk to a ton of people about their mortgage plans.

I wanna say that off the cuff you should do things in vaguely this order

Tax defer or exempt > Retirement > Prepay Mortgage

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

The 30 year will give you more flexibility should you see a decrease in income or just want to spend some money on yourself and not your house payment. But if you want to pay the least amount of money to own the home, you should go with the shorter term loan and pay as much as you can as fast as you can.

Making a half payment 15 days early can save you the equivalent of one monthly payment per year. If you do make payments in excess of the required minimum, make sure to state that those payments are to be applied to principal.

You stated that you would like to rent this property out after you have lived in it (and earned some equity in it), so your goal should be to build that equity as fast as possible, this will give you refinance flexibility in the future to buy your next property, or give you more cushion as you move into a new property and the place goes empty in between renters.

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

Why are you buying a home right now? It doesn't seem like you are very interested in this investment.

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

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Why are you buying a home right now? It doesn't seem like you are very interested in this investment.

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Why do you say that? I'd be glad to tell you why you're wrong.

This property is in Atlanta where homes aren't so overinflated and this particular one was for sale by a motivated seller. I have lived here for the past 6 years and I'm happy here and know the area. The appraisal came in at $10k above my purchase price, which I was expecting since I've been following some properties for over a year. I'm very happy with my purchase.

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

Umm... Buying homes for most people is very inelastic.

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

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Why are you buying a home right now? It doesn't seem like you are very interested in this investment.

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Why do you say that? I'd be glad to tell you why you're wrong.

This property is in Atlanta where homes aren't so overinflated and this particular one was for sale by a motivated seller. I have lived here for the past 6 years and I'm happy here and know the area. The appraisal came in at $10k above my purchase price, which I was expecting since I've been following some properties for over a year. I'm very happy with my purchase.

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OK. You're right, I guess I was "wrong", as it were.

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

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The appraisal came in at $10k above my purchase price, which I was expecting since I've been following some properties for over a year. I'm very happy with my purchase.

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You do know that the appraisal always comes in where you need it, don't you? If appraisers killed your purchase by coming in too low they wouldn't be appraisers for long.

The real way to determine if buying is better than renting is to compare the costs of both. Have you done this? In many situations today it appears that renting is mucho cheaper than owning...

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

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But therein lies the trick right? You must be paying down the principal the entire time anyway to see the advantage. If the money is spent investing, then the loan continues to amoritize at the 30 year rate and you will still owe the $81k principle at the end of year 20. Your investment will have to do about 9% ROI each year to beat the 20 year after you figure in the capital gains tax.

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Not exactly. Remember the interest rate you are paying on your mortgage is "pre-tax", after deducting your tax benefits you get your true interest rate. In reality paying down your mortgage earns you a little over 4% after tax (assuming 28% federal and 6% state) because you are losing tax benefits as you reduce your interest charges. It is similar after tax return to what you'd see from a 6.125% per year investment taxed at ordinary income tax rates. So a decent rule of thumb is that your investment returns just need to be slightly higher than your mortgage rate to make investing a better option than mortgage paydown.

And if your investments generate mostly long term capital gains, you will be better off investing the difference even if your investment returns are slightly lower than your interest rates. For example, assume your combined state and federal tax rate is 34% (6+28). Paying down a 6.125% mortage yields you a 4.04% in after tax return. But if your gains are long term, you'll only pay 21% rate (15% long term cap gains + 6% state). It only takes a 5.1% return from a taxable investment generating long term capital gains to achieve the same after tax returns.

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

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The appraisal came in at $10k above my purchase price, which I was expecting since I've been following some properties for over a year. I'm very happy with my purchase.

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You do know that the appraisal always comes in where you need it, don't you? If appraisers killed your purchase by coming in too low they wouldn't be appraisers for long.

The real way to determine if buying is better than renting is to compare the costs of both. Have you done this? In many situations today it appears that renting is mucho cheaper than owning...

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There is more to it than that. Having followed this building and 3 others specifically for over a year I was confident before the appraisal that I was getting a good deal.

The cheapest rental on the market in this particular high rise out of ~10 available rentals is $1200/month and over 93% of the units have been sold. Building opened to residents sometime early this year. I'm looking at $1680 w/HOA and power bill (HOA includes cable, internet, water, sewer, trash, insurance, etc.) and escrows before tax breaks. In the first few years I'm looking at about $1300/month with tax breaks. This is all putting ~16% down so my PMI is also $29. The loan is a 20 year fixed.

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

Desert is correct about appraisals. If I sell a house in Cali for 50k under market, the appraiser is gonna say its worth almost exactly what I'm selling it for.

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

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But therein lies the trick right? You must be paying down the principal the entire time anyway to see the advantage. If the money is spent investing, then the loan continues to amoritize at the 30 year rate and you will still owe the $81k principle at the end of year 20. Your investment will have to do about 9% ROI each year to beat the 20 year after you figure in the capital gains tax.

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Not exactly. Remember the interest rate you are paying on your mortgage is "pre-tax", after deducting your tax benefits you get your true interest rate. In reality paying down your mortgage earns you a little over 4% after tax (assuming 28% federal and 6% state) because you are losing tax benefits as you reduce your interest charges. It is similar after tax return to what you'd see from a 6.125% per year investment taxed at ordinary income tax rates. So a decent rule of thumb is that your investment returns just need to be slightly higher than your mortgage rate to make investing a better option than mortgage paydown.

And if your investments generate mostly long term capital gains, you will be better off investing the difference even if your investment returns are slightly lower than your interest rates. For example, assume your combined state and federal tax rate is 34% (6+28). Paying down a 6.125% mortage yields you a 4.04% in after tax return. But if your gains are long term, you'll only pay 21% rate (15% long term cap gains + 6% state). It only takes a 5.1% return from a taxable investment generating long term capital gains to achieve the same after tax returns.

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Does this calculation take into account the extra money paid out over the life of the 30 year loan so that at the end of year 30 one would have paid more for the 30 year loan and still come out with more cash if returns after fees avg. 5.1%?

I appreciate your response, I've already closed the deal though. Even if I may lose some value by not choosing the longer option and investing the difference, I'm more content with the safety/convenience of paying off the loan earlier than having to discipline myself and spend extra time to invest the difference each month. Somewhat results oriented thinking I guess, but it makes life simpler for me.

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

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Desert is correct about appraisals. If I sell a house in Cali for 50k under market, the appraiser is gonna say its worth almost exactly what I'm selling it for.

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Have you ever seen an appraisal before? My appraisal had 4 comparables with 2 of them being the units directly above and below mine (same floorplan) and their purchase price. I don't see how the appraiser could have been doing me a favor for better or for worse.

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

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My appraisal had 4 comparables with 2 of them being the units directly above and below mine (same floorplan) and their purchase price. I don't see how the appraiser could have been doing me a favor for better or for worse.

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Those are very good comps, but how recent are they? The markets have changed a great deal in the last 6 months.

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

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Does this calculation take into account the extra money paid out over the life of the 30 year loan so that at the end of year 30 one would have paid more for the 30 year loan and still come out with more cash if returns after fees avg. 5.1%?


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Yes. If your investment after tax returns beat your mortgage after tax returns, your investment will be larger than the extra mortgage balance, which includes the extra interest you didn't pay in order to invest.

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Even if I may lose some value by not choosing the longer option and investing the difference, I'm more content with the safety/convenience of paying off the loan earlier than having to discipline myself and spend extra time to invest the difference each month. Somewhat results oriented thinking I guess, but it makes life simpler for me.

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This is a very valid approach. Also, to get good returns from investments requires accepting volatility risk, i.e. bad years. Paying down your mortgage faster has no volatility risk. You have some small risk of trapping equity in your loan that you might need in a emergency, but in todays world it's trivial to get a second mortgage to borrow that cash back again.

Unless it's a huge difference in profitability, being able to sleep well should be a very important factor.

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

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My appraisal had 4 comparables with 2 of them being the units directly above and below mine (same floorplan) and their purchase price. I don't see how the appraiser could have been doing me a favor for better or for worse.

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Those are very good comps, but how recent are they? The markets have changed a great deal in the last 6 months.

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My appraisal was $185k, the unit directly above mine sold for a purchase price of $189.9k on 8/18/06. The other unit is on the same floor as mine and not under, but is the same floorplan, it sold for $184.9k on 5/23/06. These units were purchased from the developer. Mine is one of the first resales in the building. The "investor" who previously owned mine never occupied the unit, and judging from his purchase price and his agent fees/transaction costs on the settlement statement he lost about $4-5k depending on his closing costs.

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

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The cheapest rental on the market in this particular high rise out of ~10 available rentals is $1200/month and over 93% of the units have been sold. Building opened to residents sometime early this year. I'm looking at $1680 w/HOA and power bill (HOA includes cable, internet, water, sewer, trash, insurance, etc.) and escrows before tax breaks. In the first few years I'm looking at about $1300/month with tax breaks. This is all putting ~16% down so my PMI is also $29. The loan is a 20 year fixed.

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This is not exactly the right way to figure your costs, your monthly loan payments are much more than your interest costs since you are paying down tons of principle with a 20 year loan (which isn't a cost, it goes back into your equity), and you are ignoring the cost of locking up your downpayment with no return. The way I like to look at it is to assume you are forgoing the same return on your downpayment as you pay on your loan, i.e. 6.1%. You could quibble with this, and use a slightly higher or lower rate, but this makes a simple rule of thumb.

The rule of thumb is you apply 6.1% to the entire loan ($150k, right?), to get costs of $9,200 per year. My guess is you'll get about $2400 in tax benefits. Let's assume you pay $2k per year in property taxes and HOA, plus $350 in PMI. I'm going to skip maintenance costs since it's brand new. So your effective cost of buying is about $9000 per year or about $750 per month. Since that's $450 per month less than the rental rate, buying is clearly the better option over renting.

I'm surprised that your rental rates are so high, I'd guess that a $1200 rental would be sell for closer to $250k in my neighborhood (I know one guy who rents a brand new $200k condo for $1000 per month). It sounds like you either got a great deal or there is a big shortage of rental properties in your area (or both).

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

Depends on area. Where I'm at rents at ~1k a month and cost ~145k.

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

My guess is to why the rental may be kind of high is the $290 HOA which includes internet and cable, so a renter only needs to pay rent and a cheap electricity bill each month. Property taxes are also the highest in the state in Fulton Co. The high-rise option is the cheapest way to live kind of high on the hog around Buckhead and be in the middle of it IMO. The townhomes and houses around here are WAY more expensive.

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

I didn't realize HOA was so high. What are your property taxes? Here's how I'm calculating your ownership costs per year.

6.1% on $150k purchase price = $9150
Property taxes = $1,000 (?)
Tax break on $9k in interest & property taxes = -$3000
HOA = $3500
Maintenance = zero (for a few years)
Total = $10,600 or a little less than $900 per month.

Still way cheaper than renting. I'd usually be willing to pay a bit more than renting since owning allows you to keep appreciation. The only exception would be if you aren't going to stay long or otherwise regard appreciation as unlikely for a specific property.

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

Actually property taxes will be pretty high at ~$2500 for city and state. And $150k is loan amount, purchase price was $175k. Looks like that makes it roughly equal to renting or maybe a little more since the cheapest rental listed is 4 floors above mine.

Appreciation will probably be 3% or so average I'm thinking. From my balcony I can see the groundbreaking going on for the new St. Regis hotel and residences about 1000 feet over in the same plaza as my building and one other existing 20 story commercial building. It will be completed in 2008 and residences will start in the millions.

http://www.starwoodhotels.com/stregi...00c7b9804f58c8

Re: Help me settle this 20 yr fixed vs 30 yr fixed mortgage debate
 

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Actually property taxes will be pretty high at ~$2500 for city and state. And $150k is loan amount, purchase price was $175k.

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Sorry, you said that at the beginning, my bad.

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Looks like that makes it roughly equal to renting or maybe a little more since the cheapest rental listed is 4 floors above mine.

Appreciation will probably be 3% or so average I'm thinking.

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That would give you about a $5k per year (to start) edge owning, enough to overcome as much as a $400 per month disadvantage vs. renting. But beware, condo markets are tricky, it's easy to have large inflows of new units (conversions,etc) that can hold down appreciation. I would hope that the pullback by builders lately will be to your long term benefit.