Resetting the Mortgage Calculator

February 11, 2019

The dream of home ownership seems to ebb and flow, but in the post-2000s boom era, the challenge of buying a house is even bigger than it used to be.

And I’m going to appear to argue it should be a bit more difficult in the short term. But bear with me, because the long term reward is worth it. I also think what I propose isn’t for everyone. If you’re working hard to get into your first house or if you’re near the bottom of the market in your location, you can pretty much ignore this article. The question you should be asking is whether you should buy at all compared to moving or renting.

The Allure

A house purchase is usually the biggest buy of your life. So it’s natural to get excited about it, especially when the numbers start rolling in. Mortgage companies - keenly interested in loaning you as much money as possible - start helping you determine what you can afford. And because you’re excited, you listen. You don’t bat an eye when they say your maximum mortgage amount is $500,000. A cool half-mil. And then when your dream house comes up in the right neighborhood with the right schools and it’s just over that amount— well, you stretch. Because it’s your dream. And you can get there.

The Problem

But the cost of getting there is pretty big. It’s generally ignored in the flurry of buying a house, but let’s take a quick look. A $500k 30 year mortgage at the current average rate - 4.375% - ends up costing you a total of $898,715 over 30 years. Which means you’re paying $398,715 in interest!

There’s another problem with this too, and that’s the psychological. You’ve heard the concept of being house poor right? That’s where your house costs take up a significant chunk of your income. Buying the maximum of what you can afford is one of the easiest ways to basically become house poor. It limits your freedom and opportunities to do other things in life. As an example, let’s say you wanted to switch careers based on a new passion. Well you can’t, you need the money and can’t step backward.

Not everyone wants to do something that drastic though, so if you’re really sure about the house, the neighborhood, your life, etc.. what then? Should you take on the maximum mortgage?

I’d argue no. I think we need a new standard. The 30 year mortgage may offer you what you want - in less cases than most people think - but at a high cost of almost doubling the cost of the house. And that’s at today’s still historically low interest rates!

15 Year Standard

I’d like to propose a new standard for getting into a house. Most people should use the 15 year fixed mortgage as their standard.

Let’s see what that looks like. First, let’s take the same $500,000 mortgage from before, but this time at a 15 year length with a 3.75% rate (15 year rates are lower). Now the total cost of the house is $654,500. You’ve saved almost $250,0000 in interest!

That. Is. Insane.

And after only 15 years, you now own your own house. Zero payment. That generates both wealth and freedom. A mortgage payment is the single biggest gate to “retirement”. (Note my definition of retirement is being able to spend your time doing what you want, rather than what someone else wants.) It means a lot in today’s world. Have you ever thought about why most mortgages are 30 years long? There’s a good reason.. it’s historically been the approximate length of time of an adult career. So the expectation is that someone works for 30 years and enters retirement with a fully paid off mortgage.

And in today’s world, it’s more common for people to buy their starter home with a 30 year mortgage, then roll that into their family home with another 30 year mortgage, and then possibly do that yet again. A lot of people are starting over with a 30 year mortgage in their late 30s or 40s and staring at a mortgage payment until they’re 70.

Of course, most people probably expect to downsize when they retire, and maybe move somewhere warm. Which means that what people are really doing with a 30 year mortgage on their family house is paying rent, plus the equity in their retirement home. In other words, whatever equity they have built up when it’s time to retire is what they’ll use to get into a house with no payment.

If you plan to downsize, doesn’t it make sense to get that equity as quickly as possible, with as little interest as possible? And if you are in fact buying your forever home, shouldn’t forever come as quick as you can make it? Either way, a 15 year mortgage is the way to make that happen.

What It Means

NerdWallet has a great comparison calculator so you can see what a 15 and 30 year mortgage look like. The net effect in interest in striking, but the difference in what you can afford can also be striking. A 15 year mortgage payment will be about 145% of what a 30 year payment will be, not including taxes/insurance. So once you have the numbers on the “maximum you can afford”, a good rule of thumb is to keep the house price around 70% of your max.

That’s a good chunk less than what you perhaps expected to buy. Like I said, depending on your market and situation, this may not be for you. But a lot of people buy too much house. Another way to look at this is that the difference between the two mortgages is one or two nice car payments difference. So pay your cars off and then rock the 15 year mortgage. Or just be house poor for a little bit. If you’re going to be house poor, at least do it for freedom instead of to put a whole bunch of interest in the hands of some bankers.

Two House Plans

So how does this fit into plans for two house living, if you’re into that? Well, I can tell you for sure that having two mortgages is no fun and a nice ball of stress to deal with. We’re working on that hard, but I think the 15 year mortgage angle would have been even better.

If you’re lucky enough to get into a good house with a 15 year mortgage at 30, you can have it paid off at 45. At that point, you have the freedom to pursue a vacation house with a spending rate that you’ve grown used to. You’ll never have more than one mortgage and you’ll always feel comfortable with your expenses. And mid-40s is a great time to buy a vacation home. Your kids are old enough to really enjoy it, and you’re old enough to start preparing for retirement and what that might look like (again, using the definition above.)

So think ahead. Especially when you’re still young (40s and under), mortgages are hard to think about properly. But try to think on the order of decades. It’s worth it.

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