Dear Monty: Should we have a 20% down payment and a 15-year mortgage?
By Richard Montgomery
Reader Question: Choosing a fifteen-year loan as opposed to a 30-year term is advice we often see from financial experts or mortgage lenders. We also find information about a home buyer saving until they can make a twenty percent down payment when they buy a home. The experts that proffer this advice confuse us, as we are not yet in that position, but we feel like we can buy now. Would you advise readers to obtain a fifteen-year loan over a thirty-year mortgage and to hold off buying until they have saved a twenty percent down payment?
Monty’s Answer: When to buy a home and how to finance it are highly dependent on a variety of personal circumstances that suggest it is questionable to advise every buyer to save a twenty percent down payment and obtain a fifteen-year mortgage. It indeed is “safe” advice, and there are advantages to both of these strategies, but many consumers can, and do, safely benefit and enjoy the fruits of homeownership with a small down payment and a 30-year mortgage. Anecdotally, my bet would be the large majority of homebuyers today that obtain a mortgage put less than 20% down and choose a 30-year mortgage term.
Times have changed
As home prices have risen over the years, it could take a long time for many of us to save a twenty percent down payment. Both the U.S. mortgage regulators and mortgage lenders recognize this fact and have gradually changed their requirements by adding new products and improving existing programs with terms that better suit today’s homebuyers. For example, one of America’s largest banks recently introduced a mortgage loan product for income-qualified homebuyers with a 3% down payment and no mortgage insurance required. There are specific qualifiers, like maximum income requirements, but many people will qualify for it. It is a safe bet that other lenders will follow suit with similar products. There are also mortgage terms longer than 30 years.
Qualified veterans have been able to buy homes with no down payment for many years. FHA loans with as little as three percent down payments are available. Some lenders keep “in house” portfolio loans and gain flexibility with loan requirements. It pays to shop for a home mortgage.
A 30-year loan versus a 15-year loan
A basic mortgage qualification is about 28 to 30 percent of gross income for total housing costs. Here is an example with a 30-year loan and a $50,000 income. You have $14,000 to spend on housing or $1,166 per month. At a 4% interest rate, $1,166 will support a $245,000 mortgage. A 15-year mortgage at a 4% rate with $1,166 for housing costs will support a mortgage of $158,000. It is easy to see why the 30-year loan is so popular.
The flaws in comparing mortgages
The argument for the 15-year loan often does not mention two significant facts when deciding which term is best for you. The most notable flaw is the fact that most consumers will not live in the house for 30 years. A quick Internet search uncovered separate articles that state the average term of ownership in a home is 5, 7, 9, or 13 years. Regardless which one you believe, they dramatically change the projected 30-year interest costs comparison. Another fact often not mentioned is the mortgage interest deduction. The more interest you pay, the more significant your tax deduction. It is likely not considered because it is an indirect benefit, but you realize the advantage in a smaller tax bill, or bigger refund checks every year.
Buyer circumstances that affect the decision
A variety of factors influence what the lender is willing to lend and what the borrower is willing to borrow. The more positive circumstances a buyer brings to the table, the more latitude in the 28-30% percentage allowance for housing. From the lender perspective, credit score, borrower debt payments, gross income, type and location of the home, buyer net worth, employment stability, and type of work are all part of the qualification. For the buyer, perceived job stability, the chance of advancement, confidence in the ability to save, and risk tolerance are (or should be) considerations in the loan search.
Which loan should it be?
Some consumers chose the 15-year term, and others the 30 years. There are other types of loans as well. Your circumstances and your life experiences are the keys to choosing the right loan for you.
Richard Montgomery is the author of “House Money – An Insider’s Secrets to Saving Thousands When You Buy or Sell a Home.” He is a real estate industry veteran who advocates industry reform and offers readers unbiased real estate advice. Ask him questions at DearMonty.com.