Should You Get a 30-Year Mortgage? - Pinyo Bhulipongsanon

One of the most popular home loan options is the 30-year fixed-rate mortgage. As part of the home loan process, your lender will send you a Closing Disclosure, which shows you many useful information, including the total amount of interest you will be paying over the life of the loan. For example, let’s say you buy a $300,000 home with 20% down using a 30-year fixed-rate mortgage at 3.25% interest rate, you are looking at $136,141 in interest over the life of the loan (you can use this calculator to check the numbers). Naturally, most people will ask if it is worth it to pay over $136,000 in interest for a $300k house. The answer is absolutely YES!

4 Reasons Why a 30-Year Mortgage Makes Sense

#1 – You Can Own for Less than Rent

In my area, monthly rent for a $300k house is about $1,800 a month. If you were to go ahead and purchase this house, your monthly payment would be about $1,425 a month. Even if you have to pay $375 a month for repairs, you’re still breaking even. However, rent tends to go up each year, so you will be paying more to rent the same house in a few years, whereas your mortgage payment will only go up slightly to reflect the increases in property tax and insurance premium.

From a monthly cash flow perspective, it is cheaper to own than it is to rent the same house.

#2 – It is NOT Practical to Buy with Cash

What about saving up $300,000 to buy the house so you can avoid paying interest altogether?

If you try to save for the entire $300,000 by saving $1,500 a month, it will take you 200 months or about 17 years to save that money. However, there are two distinct problems:

You still need to pay rent for the next 17 years. We already established that it costs more to rent, especially as rent increases each year. For most people, it is not practical to save $1,500 a month on top of paying rent.
Inflation. Home values increase on average at the same pace as the inflation rate. In the last 17 years (from 2003 to 2020), we saw a cumulative inflation rate of 39.3%. Assuming the next 17 years is going to be about the same, we can expect a $300,000 house today will cost about $418,000 in 17 years. This means that your 17 years period is going to be a lot longer because you are chasing an ever-increasing number. To save the amount you need in 17 years, you will have to (1) you increase your $1,500 a month saving by the inflation rate each year, and (2) the money you already saved has to have a return that is better than inflation. (use this inflation calculator to check the numbers).

In short, unless you already have the money, saving up to pay the entire purchase price of a house is impractical.

#3 – You Win with Home Price Appreciation

Remember, inflation helps increase your home value over the 30 years. From the example above, $300,000 will be worth about $588,500 in 30 years. This means that the money you paid, e.g., $300,000 plus $136,141 in interest, will still be less than what you own at that time. From this example, you will be about $152,000 ahead!

The rate is so low right now that we can even make the number work with as little as 5% down. When you put 5% down, your monthly payment goes up to about $1850 (including about $225 a month in private mortgage insurance premium). Over the life of the loan, you would’ve paid about $161,600 in interest and about $24,000 in mortgage insurance, for a total of $485,600.

#4 – You Have Equity

But here is the real kicker, after 30 years, you own a $588,000 house that you paid $436,000 for. When you are ready to sell your house, you will be able to pocket most of the home value. Assuming about 6% cost to sell, you can walk away from the house with $550,000 in your pocket.

On the other hand, if you rent the same house at $1,800 a month and the rent increases by 2% a year on average, you would’ve paid a total of $876,000 in rent over 30 years — and the money is gone! Even if we start more conservatively and say that you can rent the same house at $1,425, you would still have flushed $694,000 down the toilet.

Bottom Line

The total amount of interest you pay over the life of the loan may look like a big number. However, the benefits of homeownership far outweigh the interest you have to pay. In my opinion, the only time it makes sense to rent is when you are sure you will not be in the area for more than five years, or you are anticipating a major life event like changes to your job or family situation.

If you’re ready, don’t wait another minute to buy a house. It will be one of the best long-term investments you can make.