The U.S. is an outlier in offering a 30 year mortgage. Here’s why that is, and why you still want to be able to pay it off faster.
It’s official: 30 year fixed-rate mortgages in the U.S. have reached 7%. This is up from 3% less than a year ago.
It’s a time where would-be homeowners are given to despair, fearing that they have missed the homeownership train.
As I’ve argued, I think this is probably a blessing in disguise, as being forced to spend extra time waiting to buy a home means that you can potentially save up more money, which will make the home more affordable when you’re ready to buy.
And by then, mortgage rates might come down too.
But all of this focus has been on the 30 year mortgage. Why is that?
Well, I can’t find specific figures, but I do know that it is by far the most common mortgage in the U.S.
And while I don’t think that it’s a good idea for you to take 30 years to pay off a home, I think we should be glad that 30 year mortgages exist.
Because, in most places, they don’t.
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Almost no other country has a 30 year fixed mortgage
You may not know this, but 30 year fixed rates mortgages are extremely rare in the world.
In face, according to a report by Bloomberg in 2019, Denmark is the only other country that offers one on the regular.
Why so uncommon?
Why is the 30 year mortgage so rare, when it’s so common in the U.S.?
My opinion is, it’s a bad deal for lenders.
Over the course of three decades, interest rates could go all over the place. Remember that in the 1980’s interest rates were almost as high as 20%.
So if you as a buyer lock in a low rate, you are truly screwing the mortgage lender, who will in effect be subsidizing your mortgage as the interest rates they continue to pay off rise.
(Shed a tear, I know.)
In fact, the only reason mortgage lenders even offer it is because they are backed by the federal government. Yes, Fannie Mae and Freddie Mac, the twin gods of U.S. mortgages which exist to help make homeownership more affordable.
So for all you free-market goons who think that we should get the gummit out of the housing market, well, good luck with your adjustable rate mortgages.
Which is exactly what’s happening in the rest of the world. For example, In Britain, 2-3 year fixed rate mortgages are the norm, meaning that every few years, the interest rate floats.
Where do you think they are floating now?
Think about that. As I wrote in a previous article, every percentage point on each $100,000 borrowed can add $60 to your monthly cost in a 30-year fixed rate mortgage.
As Axios reports, in Britain, someone currently paying £863 a month ($1,000) could wind up paying £1,490 ($1,730) soon.
And this is after they’ve gotten the mortgage.
So you should be grateful that you have the option of a 30 year fixed rate mortgage.
Pay a 30 year like a 15 year
Now, unlike some financial gurus, I don’t have any problem with you getting a 30 year mortgage.
But—and this is big—only if you can pay it off like a 15 year mortgage.
To use an example, a $300,000, 30 year mortgage at 7% would cost about $2,000 a month (principal and interest only).
That same amount and rate but on a 15 year mortgage would be around $2,700.
So if you can pay off that mortgage by spending $2,700 a month, go get a 30 year mortgage.
Here are just some of the benefits:
- You’ll get rid of PMI much faster
- You’ll save tens of thousands of dollars in interest over the life of the loan
- You’ll be paid off much quicker (obviously).
Why not just get a 15 year mortgage?
So why not just get a 15 year fixed rate mortgage then? After all, rates on 15 year mortgages are almost a whole percentage point lower.
Because of emergencies.
If you lose your job, or have another similar disaster event, you’ll appreciate the flexibility of being able to pay hundreds of dollars less, without having to deal with forbearance. It’s a built-in insurance plan.
This is exactly what happened to me. I got a 25 year mortgage (essentially splitting the difference between 15 and 30) and when I was laid off, you bet that I took advantage of the lower payments available to me.
Be glad it exists
So on balance, you can be glad that the 30 year fixed rate mortgage exists. It is designed to make homeownership more affordable, and certainly increases your flexibility.
Just please, don’t spend 30 years paying off your home. That’s the worst possible outcome, not only for the lender, but also for you.