As many of you may (or may not) know, I am considering buying a home in Des Moines. It is a big decision but even a bigger investment. To be honest, I did not know much about how mortgages worked, property taxes, PMI insurance, etc. before a few months ago and I admit that I still have a lot to learn. That being said... I've come to the conclusion that the 30-year mortgage is a bad investment. Too many people are figuring out "what they can afford" by calculating the highest monthly payment on a 30-year mortgage. Looking at the numbers, that should NEVER be the decisive factor when determing what your price range is for a house. Here's why --
Jake & I currently pay $1,150.00/month in rent. We're pretty comfortable with that. So the obvious conclusion would be we can afford a whatever-priced house that would equate to a $1,150.00 mortgage payment on a 30-yr mortgage. OK.... that may be true. But the question is whether or not it's a worthwhile investment, or if we'd be better off renting. More numbers --
Loan amount: $150,000
Interest rate: 6.5%
Property tax: 1.25%
PMI insurance: 0.5%
Scenario #1: We live in the house for 30-years and pay it off
Total interest paid: $202,816.73
Total tax paid: $60,000.00
Total PMI paid: $7,250.00
Total payments: $420,066.73
House value assuming 2% appreciation each year (after 30 years): $266,376.70
House value assuming 3% appreciation each year (after 30 years): $268,988.24
House value assuming 4% appreciation each year (after 30 years): $271,599.78
The numbers don't lie -- we will have paid more $$ in interest, tax and PMI than the house is even worth after 30 years.
Scenario #2: We live in the house for 5-years and then move
Total interest paid: $45,778.38
Balance on the loan: $140,788.47
House value assuming 2% appreciation each year (after 5 years): $162,364.82
House value assuming 3% appreciation each year (after 5 years): $163,956.64
House value assuming 4% appreciation each year (after 5 years): $165,548.45
Let's say we sold the house for $165,000 -- our home equity would net $24,759.98. We could use that for another downpayment and continue the cycle over and over and over. Of course, I'm not trying to belittle the $25k in home equity -- that is great, but when you consider that you paid double that in interest and taxes, it doesn't seem like such a brilliant investment.
Maybe. But... I think I've come up with the best solution.
When considering what house price you can "afford" -- run the numbers on a 10-year or 15-year mortgage. For example... figure out what loan amount you can afford with the same monthly payment but only a 10-year loan term. For me that number is $90,000. With a down payment to add on top of that, I could afford a $120,000 house with these numbers --
Loan amount: $90,000
Interest rate: 6.5%
Property tax: 1.25%
PMI insurance: 0% if you put 20% down
Total interest paid: $28,881.82
Total tax paid: $15,000
Total PMI paid: $0
Total payments: $131,882.82
Assuming the house appreciates 3% every year, after 10 years the house would be completely paid off and valued at: $161,269.96. Adding the $30k down on top of the $132k of total payments, you are almost breaking even.
THIS is the scenario I consider a solid investment. Now that the house is paid off, one could choose to either "live for free" (except for property tax, homeowner's insurance, etc.) or put some of that money back in towards a down payment. Now that you would have more to put down, you could essentially do the natural progression of buying a bigger and better house.
Conclusion: Pay off your house at the 10 or 15-year mortgage rate. Otherwise, in my opinion, you'd be better off renting and investing your extra money not spent on maintenance costs. Save the money invested until you have a large enough down payment to afford (based on definition of "afford" in the above argument) the price of house you want to live in.
Assuming the house appreciates 3% every year, after 10 years the house would be completely paid off and valued at: $161,269.96. Adding the $30k down on top of the $132k of total payments, you are almost breaking even.
THIS is the scenario I consider a solid investment. Now that the house is paid off, one could choose to either "live for free" (except for property tax, homeowner's insurance, etc.) or put some of that money back in towards a down payment. Now that you would have more to put down, you could essentially do the natural progression of buying a bigger and better house.
Conclusion: Pay off your house at the 10 or 15-year mortgage rate. Otherwise, in my opinion, you'd be better off renting and investing your extra money not spent on maintenance costs. Save the money invested until you have a large enough down payment to afford (based on definition of "afford" in the above argument) the price of house you want to live in.
