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Rowling & Associates Blog

Planning for the Optimal Mortgage Option for You

by Shalmali Kulkarni

Purchasing your dream home has many steps, including the decision between the myriad mortgage options available to you. Often when you meet with a mortgage broker, he or she will offer you a few options with different rates and different time periods. How will you know which option is ideal for you? While there is no one right answer for everyone, considering the details of your unique financial situation will help you when planning for the optimal mortgage option for you. 

financial planning for home mortgage scale balancing home and finances

Home Mortgage Base Scenario

For the purposes of this post, we will take one base scenario and apply it to three different financial situations to show the various considerations you will likely make when planning to obtain a home mortgage. Here is the scenario we will use:

Cost of home: $500,000.

Down Payment: 20%.

Mortgage: $400,000

Mortgage Loan Option #1: 30-year Loan at 2.875% interest

Mortgage Loan Option #2: 15-year Loan at 2.25% interest

Planning for a Mortgage if You’re Cash Strapped

If money is tight for you, a 15-year mortgage loan with 2.25% interest probably sounds like a no-brainer. With this loan, you will have your house paid off sooner, and the interest rate is lower too. But it’s important to remember when planning for a mortgage that what looks good at first glance may not actually be the right option in the long run.

When you actually run the numbers with this example, you’ll see that the monthly payment for the 15-year loan will be significantly higher than that of the 30-year loan. Ask yourself honestly, “Do I have enough cash available for a higher payment?” If the answer is no, it makes sense to go with the 30-year loan. This will give you some breathing room in your cash flow, and you won’t risk your credit (or foreclosure!). If you find yourself with leftover cash, you can always make extra payments toward your home mortgage throughout the year. These will be directly applied toward your principal, thus reducing your total interest paid over the term of the loan.

Financial planning pro tip: If you do have additional cash left over after your minimum monthly mortgage payments, you can also invest it. Because interest rates are so low right now, as long as your after-tax return is greater than the after-tax cost of your mortgage, you will actually come out ahead with the 30-year mortgage. Not a bad option if you are strapped for cash!

Having Plenty of Cash to Plan for Payments

If you have sufficient income to make minimum payments toward a 15-year loan, it might make sense to go with this option. Taking this loan could actually work as a form of forced savings for you because much of your money will be directed toward these payments. Over time, you will end up paying less interest as compared to a 30-year loan. Once you have completely paid off your mortgage, you can redirect that amount to an investment account.

However, there are benefits to taking a longer-term loan as well, even if you have sufficient income for the shorter-term. If you have the self-discipline to direct leftover cash toward savings, a 30-year loan will actually leave you better off in the end. Not only will you benefit from investing the excess cash in the market and participating in the upward market growth, but you can also continue to take a mortgage deduction for 30 years. This will reduce your taxes, which puts more money in your pocket!

Preparing for Retirement with a Mortgage

Imagine that you are about to retire and will soon be living off of Social Security and your savings. Perhaps you are purchasing a new retirement home or are looking to refinance your current residence. Or perhaps you are mid-way through your mortgage payments and are wondering if you should simply pay off the balance now, while you are still working.

There is a lot to consider here! For starters, if you are purchasing a new home or refinancing, taking the option with lower payments gives you fewer expenses per month. This way, you will have more money in your accounts, which can continue to grow with the market. Even during retirement, most people still owe income taxes due to required minimum distributions, pensions or annuities, and Social Security payments. So, an interest deduction remains favorable.

But this doesn’t mean that the 30-year option with the lower interest rate is always a good option for you. What if you are very risk averse and are mostly invested in fixed income earning less than your mortgage interest? In this case, it makes sense to try to pay off your mortgage as soon as possible since your mortgage actually costs more than the interest you are earning on your investment.

And, there is still more to consider! What if paying off your mortgage early is a peace of mind decision? If eliminating these payments early will allow you to enjoy your golden years, then you may want to choose the 15-year option that allows you to pay off your mortgage as soon as possible.

When planning for a mortgage, you will be given many options to consider.

The most important thing to remember is that there is no one right option for everyone! As is the case with many aspects of financial planning, your unique situation, goals, and feelings will all help to determine the ideal option for you. If eliminating big payments like a mortgage quickly will bring you peace of mind, a 15-year loan might appeal to you. If you are more concerned with saving for the long term, a 30-year loan will allow you to invest more of your money in savings.

No matter your situation, a fiduciary financial advisor is a great resource when it comes to planning for the big things in life, like a home mortgage. Contact us if you would like help with planning for the optimal mortgage for you!