Escaping the 30-Year Mortgage Trap
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Raise your hand if you’ve ever taken out a 30-year mortgage.
C’mon. Get ’em up there. Nobody is looking, I promise.
OK, now keep your hands up if you feel like you’ve been duped.
It’s true. And it’s happened to me too. Here’s how…
The Problem with a 30-Year Mortgage
A 30-year mortgage is one of the biggest financial traps around. It is also one of the most common, which is something that makes it even sneakier.
So, what’s wrong with it? Well, a 30-year mortgage encourages home buyers to spend more than they can afford, borrow more than they should, and pay more in interest than is necessary. And, unless you’re planning to stay in the home for a looooooong time, you’re going to make minimal progress in building equity.
Look, I’ve done it too. When Holly and I bought our first house, we placed our trust in the well-known, much beloved 30-year fixed rate mortgage. With it, we were able to purchase a nice, small starter home in a decent neighborhood. More importantly, the 30-year fixed allowed us to make payments that we could easily afford.
Of course, this was a starter home. We bought it with the intention of moving to a larger place sometime in the near future. Unfortunately, we didn’t quite understand why a 30-year mortgage wasn’t our best option.
Like us, I suspect that most first-time home buyers – who are typically younger – aren’t buying their dream home right off the bat. In fact, a study published in 2013 by the National Association of Home Builders estimates that a typical first-time home buyer will live in the home an average of 13 years.
See Also: House Shopping – The Addiction Continues
So, what’s the problem?
The Biggest Reason to Avoid a 30-Year Mortgage
To understand how you’re being trapped by a 30-year mortgage, you first need to understand how a mortgage works. When it comes to mortgages, interest is not spread evenly throughout the 30-years. Mortgage interest is amortized, meaning you pay more in interest on the front end of the process.
For example, if you take out a$150,000 30-year fixed rate mortgage at 4.5% interest, your monthly payments will total about $760 a month, not including taxes and insurance. Of that $760, about $560 of it goes toward interest for the year of your loan. On the flip side, less than $35 a month will be paid toward interest over the last year of the loan.
This means you are essentially renting the home from the bank for the first several years of the mortgage! Unless you stay in the home for an extended period of time, you’re going to have trouble gaining any substantial equity in the home.
See Also: Why We Prepay Our Mortgage
Unlike renting, though, you also have to pay for any repairs or upgrades to the house. So, not only are you struggling to build equity. You’re also on the hook for repairs.
As we already know, younger people and first-time home buyers tend to flock to the 30-year mortgage for their first loan. Because they grow comfortable with it, they’ll more likely to stick with it for their next purchase as well.
But, what does it really cost you?
As an example, let’s use some estimates on our current living situation. When we purchased our current house, we had a substantial down payment and the option to finance either a 30 or 15-year fixed mortgage. We chose the 15. You’ll see why when you look at how the numbers break down:
15-year fixed at 2.75% interest – We could owe total of $33,225 in interest over 15 years.
30-year fixed at 3.75% interest – We would have paid a total of $100,082 in interest over 30 years.
Big difference, right? That’s almost $70,000 of real money saved!
Most importantly, after 10 years of ownership, we will have $93,000 in equity in our house, paying just $29,150 in interest. Had we selected the 30-year, we would have just $32,830 in equity and $50,894 paid in interest.
On the downside, our monthly payments are more expensive, but we’ll look more at that in a minute.
See Also: Unison Review – How to Fund Half Your Down Payment Without a Loan
3 More Reasons 30-Year Mortgages Suck
Need more reason to avoid a 30-year mortgage. Here’s a few:
- Longer Term – Seriously, who the hell wants to be in debt for 30 freakin’ years! Good LAWD! No thank you. This is especially true for people buying their second and third home. Why in the world would you still want a house payment in your 50s, 60s, or (gasp) 70s? Puke!
- Higher Interest Rates – The longer you extend the term, the bigger the risk the bank takes on your loan. As such, you’re going to pay a higher interest rate.
- Save Money on Interest – Did I mention that you’ll pay tens of thousands of dollars more in interest? Why that when you could purchase something you can afford in a 15-year term and this is such an easy way to save money?
How to Escape the 30-Year Trap
If you’ve already committed to a 30-year mortgage, you can still get out of it and save money. Here are a few ways to escape the 30-year mortgage trap.
- Pay it Off in Cash: Easier said than done, right? But, if you’ve got the cash to do it, pay it off. Get rid of it and be done!
- Pay Extra on Your 30-Year Mortgage: By making extra payments on your 30-year mortgage, you can effectively reduce the length of your term and decrease your interest payments. In our example, the monthly payments on the 15-year are about $1,017/month. On the 30-year, they run about $695/month. If you take the $322 you save and pay the extra toward your principal each month, you can pay off your 30-year mortgage in 16 years. Because your interest rate is still higher, you won’t save as much as you would have if you started with 15-year loan. However, you’ll still save about $49,000 in interest by going this route…and that’s definitely not chump change! In fact, it’s one of the best investments with low risk you can make.
- Refinance to a 15-Year Mortgage: We’ve done this with a couple of our properties, and it has saved us tens of thousands of dollars! Using our example above, we saved almost $70,000 in interest by going with the 15-year mortgage. That’s real life money, people!!!
Where Can You Refinance?
LendingTree is a great place to search for the best refinancing rates. There, you can compare rates from several companies at once. That way, you know that you’re getting the best deal available. Compare rates for up to 5 lenders here!
To build real wealth, you need to make smart money moves. Avoiding giant debt traps will put you far ahead of your peers. While they are schlepping away to pay off their house, you’ll have left them in the dust years ago.
Remember, the quickest way to build your wealth is to destroy your debt. The faster you can get rid of it, the better off you’ll be.
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We had this very situation with our first starter home that we purchased at the peak of the market in 2006-30 year mortgage, paid very little down, high interest rate. And now, 10 years later not only is the house not worth what we paid for it, but our mortgage is even STILL higher than our mortgage balance. We recently refinanced that property with a 15 year loan (through Quicken actually even!) and are finally making some progress on paying down the principal enough to be able to sell it someday. Great real life example and all so true!
Thanks Kathryn! Sounds like you finally got out from under that loan. The thing is, when you’re buying your first home, you really don’t know what you’re doing. Now that I’ve bought several, I know better. I’m not sure if it’s experience or getting old 🙂
Hi Greg, Nice article. I fell into the same trap but realized it after paying for 5 years :(. Here is my question. I have currently a 20 year conforming loan and less than a year into it. Can I change that to a 15 year loan? Any thing that I should be looking for when I change. My Credit rating etc is pretty good up around 780+.
I would check with a bank and run the numbers. I don’t see why you can’t refinance, but that doesn’t mean it makes financial sense. Since rates are low, might as well look into locking in now before they go up! And if it ends up not making sense, you won’t be out anything but your time!
Great article filled with practical advice. I’m 35 and have never owned a house. My landlord is my father. We can’t really afford more than $700 a month (current rent is $500) and don’t want to own a piece of crap that will cost me a fortune to fix up. Do you think it is better to rent or to buy a house with payments you can afford? I’ve struggled with this question for years and still don’t know the right answer. I’ve been scared to death about buyiung a house, so I’m still renting until it makes sense to buy. In the meantime, I’ve paid off all our credit card debt and now working on the $50K student loan debt we’ve accumulated.
Owning a home is expensive! Over the last few years, we have rebuilt a chimney ($900), had multiple air conditioning and furnace issues costing thousands, etc. I would keep renting, personally. It sounds like you’re spending all you can afford, and you’re smart not to jump right into owning something that will cost lots of money!
Awesome job paying off the credit cards! Have you looked into income-driven repayment for your student loans? Or, are you just trying to kill them off completely as fast as you can?
Just trying to pay them off as quickly as we can. I feel like I’m the last one out of everyone I know not to own a house! People keep telling us that we are wasting our money renting, but I think we would have gone bankrupt owning a house! Especially since we’ve moved around a lot.
I think your strategy sounds smart. Moving is expensive when you own a home, too. Paying a realtor, closing costs, etc. I bet you are “ahead” renting, even if it doesn’t feel like it.
I think one of the big takeaways of the 30 vs 15 is you guys put yourself in a position to have that choice, (large down payment, very little to no debt). If you are unsure of an extra $300 month example, maybe you should be asking different questions like should I really be buying a home.
Thousands of dollars are kind of a big deal:)
Great point Steven! Unfortunately, a lot of people forget to ask the right questions at the right time.
Nice post, Greg! I agree that a 30 year fixed rate mortgage is not a desired route to take. I was a naive to go that route when we bought our first home.
If you are cash rich, you have several options. Even if you can pay cash for your home, it may be wiser to take a loan – 5/1 ARM or 7/1 ARM – the interest rates are even lower on these – lower than 3%, the average historic inflation rate – which means free money in your pockets.
If the interest rates go up, you could pay off the loan.
In the meantime, your cash could be invested in the market – S&P 500 index tracking ETF would provide an average annual return of 8% over the long term.
Thanks for your comment Micahel! You’ve definitely laid out the right mathematical play. Personally, I just despise debt. I’d probably take the cash, pay off the mortgage and then use that “new found” money to invest. But, again, I’d just rather be out of debt completely and not have to worry about it.
Interesting. I agree — I’m happier without debt, even if I might have made more by investing the money instead of buying a home with cash. I keep reading articles about why it’s better to take out a mortgage — the tax deduction, potential investment earnings, etc. — and I just don’t buy it. If you have no debt, have an emergency fund, and can buy with cash, why not? I sleep better at night, too. 🙂
Yes! I took out a 5/1 ARM when I bought my condo four years ago. I considered 30 vs 15 year fixed mortgages and ultimately wasn’t comfortable with the higher payment of the 15 year (though I would be now) and wasn’t comfortable with the higher interest rate of the 30 year. I went with the 5/1 ARM with the intention of repaying it within five years entirely or enough that a rate reset wouldn’t affect me too much and I’m still on track for that – I paid off the first half of the mortgage in the first 2.5 years. I’ve been prioritizing some other financial goals, so I’m unsure if I’ll pay it off in full before my rate resets in early 2018 but if I don’t, I will be very close!
Oh man, you are braver than I am with the ARM 🙂 Good work on that…and pay that sucker off before it adjusts!
Good work Leigh 🙂
It’s been a good choice so far – I’ve had a 2.5% interest rate for the last 3 years with another two to go and right now if it were to reset it’ll go to 3.5%! I also didn’t think I’d stay in my condo for more than 5-6 years, but it’s looking like we will be here for at least ten hopefully.
A 15-year mortgage sounds like a really good idea. Now all I have to do is move to a lower cost of living area that I like so that I can buy my first primary residence and then some rental properties.
Yeah, living in an area where housing is actually affordable is another key. It’s a lot harder to buy in a place like New York or San Francisco…but it can be done.
I actually gasped at finding out that of $760 mortgage payment, $560 went to interest in the first year! I’m still struggling to understand what I might get myself into when I buy my first home. Most of the people I’ve talked to in real life seem to take this as “normal” – they said at least they’re not paying their landlord’s mortgage. But I feel like there’s more to it than that – which is why I’m happy I stumbled on this post.
For now, we’ll keep working on beefing up our down payment. We haven’t found a house we like yet anyways.
Awesome! Glad you found it too Jaymee 🙂
As far as renting vs. buying goes, its a hard call. We own rental properties as well, and yes, our tenants are paying our mortgage. However, if you’re on a 30-year mortgage, you’re essentially renting from the bank for the first several years anyway. Plus, you have to pay for taxes, insurance, repairs, etc. (That $760 I mentioned in the piece is mortgage debt only. It doesn’t include anything else that may be wrapped up in your payment.)
So, unless you can afford a 15-year mortgage, you may want to wait. As Steven said earlier in the comments, if you’re unsure that you can afford a few extra hundred dollars a month, you should maybe ask the question if you can afford to buy at this time.
Keep stockpiling money and beef up that down payment! Good luck and thanks for visiting 🙂
Those numbers are scary and it is ridiculous that the frontload the interest that way. Many think that the amount of interest would be staggered over the life of the loan so it’s good you’re pointing this out.
Yeah, it is definitely not spread out. In the beginning, you’re not building much equity at all. That’s why it’s really important to stick around for a while.
I am thankful I am not yet in the rut of a 30-year mortgage. Before this happens, I’d prepare so much so that the effect of this mortgage become lesser. Greg, we know that once we are in this, it is like we have less control to still achieve financial goals. Preparation is what I think very helpful.
What do you think about using a 30-year to accelerate debt-repayment? Here’s what I mean – I’m currently in a 15-year, but it’s taking up about 25% of my net income. Meanwhile I’m trying to pay off about $17,000 of debt. We’ve lowered our expenses over the past couple years and our incomes are pretty flat (i.e. no side hustles generating extra income), so the debt payoff is going pretty slow. I’ve thought about refinancing the 15 into a 20 or 30 to generate lower monthly payments and then using the difference to accelerate the debt payoff. Then once the $17k of debt is gone I can just pay extra on my mortgage. Right now I’m eating away very quickly on my mortgage, but I’m more interested in eating away at my other debts first.
I absolutely love that you’re wanting to pay off that $17K in debt! Seriously man, LOVE IT! Here are my two cents on the matter:
If your mortgage is eating up only about 25% of your income, you are probably in great shape to pay off that debt quickly! I have no idea what your income or expenses are, but my hunch is that there is a lot more room to pound out that debt without refinancing to a 30.
If it were me, I’d take a look at my budget and look for ways to get down to live on the bare bones. Let’s assume you make 60K/year, which is roughly $4,000 a month in take home pay. 25% of that ($1,000) goes to your mortgage, so you have $3,000 left every month. Living on half of that ($1,500) should be no problem, right? Using either the debt snowball or debt avalanche method, throw the other $1,500 at your debt each month. It will be paid off in about a year! Boom!
Again, I have no idea about your specifics, and this is simply what I would do. I’d be happy to take a look at your numbers and your budget if you shoot me an email!
Good luck man! Again, I love that you want to get rid of that debt!
I started my first place with a 20 year fixed, but refinanced a few years back into a 15 year fixed.
I\’ve been tempted on occasion to consider an ARM, but am still very conservative when it comes to my primary residence. Been through too many layoffs, recessions, and other unexpected events to trust my shelter to random market movements.
Yeah, I just don’t trust the ARMs either. Some people can make them work to their advantage and pay them off before they adjust, but you’re playing with fire.
This is why we live in a place where you can get housing dirt cheap. We did not want a mortgage, so we opted to move to the “hood.” Schools are not good at all…but no mortgage allows us to home school. As home schoolers my kids get an education they wouldn’t get in even the best private school. So it worked out better than we anticipated. It’s not for everyone, but it’s been a good decision for us.
Wow, I used to think this way when interest rates were higher, but I don’t now. A 30 year mortgage lets me leverage my money and provides a hedge against inflation. Some day in the not-too-distant future, people will kick themselves for not hanging on to their ridiculously cheap mortgages and investing in the stock market or real estate (to name two of many options) instead. Perhaps you could cover these concepts in a future post.
I had a 7/1 ARM at 3.625% but then it was too risky as it can adjust to 8.625% in the 8th year itself.
Initially I was rushing to pay it off (with double extra payments) but that would have left very little to invest.
I refinanced to a 30 year fixed, as that would stabilize the rush and give me about 11-12 years to pay it off.
I know the monthly payment and interests are higher, but as I ran the numbers I found it beneficial to go fixed.
15 years would have been better but then I have a large part of my net worth tied to paid off properties, hence going a little easy on this and invest on stock markets. I have no other debt.