September 26, 2018
by: Robb Flannery
When getting a home mortgage, if you can afford higher payments, often the option of a 15-year loan instead of one of 30 years is an option. It can be an enticing idea to know that you'll be free of a mortgage in half the time and pay a lot less interest in the process.
Using a $200,000 mortgage as an example, the payment (P&I, Principal, and Interest, not including escrow for taxes and insurance) is approximately $955 at a 4% mortgage interest rate. You'd pay a total of $343,739 over that 30 years. At the same rate, a $200,000 mortgage over 15 years would require a P&I payment of $1,479 at the same interest rate, and you'd pay a total of $266,288 over the life of the loan.
If you can make those higher payments, it's a nice bonus to save around $80,000 over the life of the mortgage of 15 years. There is another option as well. You can cut your mortgage time by five or more years if you get your lender to set you up for bi-weekly automated payments. Instead of paying one monthly payment x 12, half of the payment amount is paid every two weeks. Because some months have five weeks, you end up paying the equivalent of an extra payment each year. It's a relatively painless way to save money over time and pay off your home sooner.
What about something else?
So far, the discussion is comparing different payment structures at a 4% mortgage interest rate. It could have been 5%, and there would have been more overall savings, but with higher payments. The 'something else' is taking a look at your other debt, especially credit cards, store credit, or signature loans. Estimates vary from around $6,500 to over $9,000 for average credit card debt per household. Along with that, multiple sources report the average credit card interest rate rose to 15.59% in 2018.
Going to the middle, a $7,500 total in credit card balances with a 15.59% interest rate would mean that around $98 of the payments goes straight to interest each month, not reducing the balance for that out-of-pocket expense. At almost $1,200/year in interest payments at interest rates often triple rates on a home mortgage, perhaps paying off debt is smarter than working on the mortgage.
If you go back to the comparison between a 15-year and 30-year mortgage, the increase in monthly payment is $524/month. Perhaps a far better plan would be to pay off that $7,500 in card debt by adding the $524/month to payments. You would be getting rid of that debt in around a year or less. Then, you can start to work on extra payments toward the mortgage if you want. Even if you would have taken the approach of adding principal money to every house payment on the longer mortgage, you're decreasing a 4% or 5% debt with money that could be working down debt at a much higher interest rate.
There is a lot of data showing that the internet has shortened attention spans and has increased the desire of Canadians for immediate gratification. You're certainly pushing out that gratification with the mortgage payment approaches, while you could be getting much faster gratification by paying off short-term higher rate debt. Then you can work on the mortgage.