Unexpectedly Intriguing!
April 20, 2010

If you're shopping for a mortgage these days, you're probably already aware of the pros and cons of the different kinds of mortgages out there.

We'll guess that based on the experience of the recent past, you've probably already rejected the idea of using Adjustable Rate Mortgages (ARMs) to finance the purchase of your next home, with the better idea that you don't want to be one of those people forced to scramble to come up with more money or else go through the foreclosure process when mortgage rates begin to rise from their current lows.

So you've probably narrowed your options down to fixed-rate mortgage products. But here, there are other questions to answer, like "how long do I really want to pay for my house?" and "how much do I want to pay each month?"

Mortgage and Economic Data
Input Data Values
Mortgage Principal (Amount Borrowed)
Annualized Rate of Inflation [%]
Marginal Income Tax Rate [%]
Input Data Shorter Term Longer Term
Mortgage Term [Years]
Mortgage Interest Rate [%]
Monthly Mortgage Payment Comparisons
Calculated Results Longer Term Mortgage,
Paid Over Longer Term
Shorter Term Mortgage,
Paid Over Shorter Term
Longer Term Mortgage,
Paid Over Shorter Term
Amount of Regular Mortgage Payment
Difference from Longer Term Regular Mortgage Payment
Cumulative Mortgage Payment Comparisons
Total Amount Paid Over Life of Mortgage
Savings Over Total Amount Paid for Longer Term Mortgage
Net Present Value Mortgage Comparisons
Net Present Value of Mortgage, Adjusted for Taxes and Inflation
Our latest tool can help you answer these questions! We've taken math developed by Helen Maynard over at her blog, Science and Money, where she worked out the net present values for mortgages of different durations, incorporating such factors as the tax deductibility of interest payments and inflation over time.

But better still, she asked a great "what if" question: "What if I get a 30-year fixed rate mortgage, but then pay extra each month to pay it off in 15 years?

That opens up an interesting opportunity for today's homeowners, in that they would be able to effectively reduce their payments by the extra amount they're putting into the mortgage to pay it off early should they run into real financial difficulty. Without ever having to negotiate new terms with their home lender and never having to go through President Obama's impotent mortgage modification program!

Needless to say, we couldn't pass up the challenge to convert Helen's math into an online tool you can use to do the math for yourselves. Enter the data and mortgage rates you're considering for your situation below, and we'll do the rest....

In our tool, we've assumed that the different mortgages are paid on a monthly basis. This allows us to make an apples-to-apples comparison with the payment schedule of the most common mortgages available in the United States.

Meanwhile, our default case assumes that the amount of the annualized rate of inflation is the same as the average observed for all periods of time greater than or equal to one month in duration in the United States since 1913 and that the marginal tax rate that applies is 28.0%. You're certainly welcome to adjust these figures as you see fit!

In comparing the results for our default scenario, we find that the net present value of the 15-year mortgage works out to be the lowest total cost option overall. So, for an extra $440.96 over what you would have to pay each month for a 30-year mortgage, you would save $119,421 total over what you would have to pay over the life of the 30-year mortgage.

However, we also see that the option of taking out a 30-year mortgage, but paying it off in 15 years, adds just $6,375.45 to that low net present value.

Converting that slightly higher net present value into real money terms, that means that for the extra $62.39 per month over the cost of a 15-year mortgage, you would save $108,191 over what you would have to pay over the life of the 30-year mortgage. Plus, you would be able to reduce the amount of your payment by 31% at any time if you should need to without any consequences other than having to pay off your mortgage over a longer period of time.

In the meantime, the homeowner also benefits by the faster rate at which they accumulate equity in their property, which is something that can also be tapped in case of a serious financial emergency. Which means that when it comes to mortgages, buying long but paying short might be the cheapest insurance a homeowner can have to deal with an uncertain future!



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