Choosing Your Mortgage Length
In order to know how much you'll need to save to buy a house, you first need to make some basic mortgage decisions. This section (as well as the next two) helps you understand some of the financial decisions surrounding buying your house.
Although choosing your mortgage length may seem like a simple, straightforward decision, it's actually one that will have a tremendous impact on your financial security over the next several decades of your life.
30-Year Versus 15-Year Mortgages
The majority of Americans getting a new mortgage on a home opt for a 30-year loan without even considering other options. A 30-year loan is what all your friends, family, and neighbors have probably signed up for, and it does make the monthly payment much more affordable than a 15-year mortgage.
So what's the problem with getting a 30-year mortgage? Although the following is a general statement that doesn't hold true for every mortgage amount and every interest rate, here's a simple rule of thumb: With a 30-year loan, you'll end up paying a little less than one and a half times the mortgage amount in interest over the life of the loan.
This means that if you buy a $100,000 house, you'll pay nearly $140,000 in addition to the price of the home, just for the privilege of stringing the payments out over 30 years.
Now think about what you could do with $140,000! That would make a pretty good retirement nest egg, wouldn't it? Whatever you'd like to spend $140,000 on, spending it on virtually nothing doesn't seem like a very good idea, yet that's what you do when you get a 30-year loan.
Your equity (the value of your home minus the amount of your mortgage) increases as you pay off your mortgage and as your house increases in value. If you pay more than the amount due each month, you'll increase your equity much faster than if you pay only the minimum amount due.
Proponents of mortgages will tell you that because you can deduct the mortgage interest on Schedule A of your federal income taxes, spending all that money on mortgage interest is a good idea, but the numbers don't bear that out.
Suppose you pay $6,400 per year in interest on your mortgage, and you're in a 22-percent tax bracket. This means you can deduct $1,408 from your taxes this year. Over the life of a 30-year loan, that's $42,240 in taxes you don't have to pay and can put into your retirement, business, or Corvette fund. But if you pay $140,000 in interest over those 30 years, you're still out nearly $100,000 in interest!
A better idea is to reduce the life of your loan to 15 years, or less. If you pay off that same house in 15 years, you'll pay only about $60,000 in interest and get about $10,500 in tax savings. This means that by paying off your mortgage 15 years early (even if you take the tax deductions), you've earned yourself a $50,000 gift.
Generally, you'll find two lengths of mortgages: 15 years or 30 years. Occasionally, you might be able to get a mortgage for a length other than 15 or 30 years, but few lenders offer them. If your goal is to pay off your house in full as soon as possible, and if you have a large down payment, ask about a five- or 10-year mortgage. They're rare and may require some additional costs and paperwork, but locking in to a short mortgage will force you to pay it off quickly.
Paying Any Mortgage Off Early
Another way to shorten your mortgage, however, is to simply pay more than the required amount each month. Here's another simple rule: If you make one extra payment per year (or if you divide the amount of one payment by 12 months and add that to each month's payment), you'll cut about seven years off the life of your 30-year loan.
How do I pay off my mortgage in 10 years?
To pay off your house in 10 years, use a mortgage calculator (or ask your lender) to figure out how much extra you'll need to pay each month. Pay that extra amount each month, and in 10 years, the mortgage will be paid off.
Although you may want to lock in the shortest possible mortgage length to take advantage of the lower interest rate that goes along with it, going with a longer mortgage length may give you more flexibility in your finances.
For example, you can get the great rate associated with a 15-year loan, but plan to pay it off in 10 years. Of course, if you're not disciplined enough to pay the extra, lock in that higher payment.