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

scotchnrocks · #1 10-27-2006, 07:09 PM

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 ?

Big TR · #2 10-28-2006, 09:12 AM

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.

scotchnrocks · #3 10-28-2006, 03:34 PM

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.

leto333 · #4 10-31-2006, 09:24 PM

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.

shark6 · #5 10-29-2006, 12:56 AM

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

[/ QUOTE ]
This is a bad assumption.

[ QUOTE ]
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.

scotchnrocks · #6 10-29-2006, 02:07 AM

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.

maxtower · #7 10-29-2006, 03:27 PM

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

Thremp · #8 10-29-2006, 03:58 PM

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?

scotchnrocks · #9 10-29-2006, 07:36 PM

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.