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The 20 Year Fixed Rate Loan: Sexy...No, Great Loan...Yes

Most people take out a 30 year fixed rate mortgage because they want the lowest possible mortgage payments and because the 15 year fixed is just too expensive for them, but the 20 year fixed is a loan EVERYONE should consider.

With a 30 year mortgage very little of your hard earned dollar goes towards reducing the principal on the loan.  In fact, most people would be surprised to know it takes until the 21st year before they have paid off even HALF of their 30 year loan.  And they would be even more surprised to know how little extra it costs to do a 20 year fixed and how much they would save if they did.

The 20 year Loan Forces You To Save

A 20 year loan is like a “forced savings plan.”  Think about it.  How many of us would have retirement money set aside if we didn’t have a 401K?  The 20 year loan forces you to pay more than you think you can in much the same way that a 401K forces you to save for retirement with money you didn’t think you could live without.  If you don’t have the money you can’t spend it and if you HAVE TO pay a few hundred more dollars per month for the roof over your head…you will.  Many people have great intentions of paying down a 30 year fixed rate mortgage over less than the full term, but they never do.  With the 20 year fixed you don’t have to think about making extra principal payments because the extra principal is already in the payment.

Take a look at these numbers assuming a loan of $175,000 and a house valued at approx. $220,000:

Monthly payment at 5.875% for a 30 year fixed:  $1035.19

Monthly payment at 5.75% for a 20 year fixed:  $1228.65

The 20 year fixed rate is only $193.46 more per month

$193.46 seems like a lot more money to shell out each month, but if you look at it in other terms you can see that it may not be that difficult to come up with the cash.  If you break it down to a daily amount you see that it is $6.45 per day.  That’s right…for $6.45 a day you could knock 10 years off your mortgage.  That is $124,222.80 in savings.  But where do you come up with that money you ask?  Some ideas:

  1. Brown bag it.  $6.45 is about the cost of 1 fast food combo meal.  Your wallet and your heart will appreciate it if you pack a lunch.
  2. Renegotiate your credit card rates.
  3. Empty the coins in your pocket (or car) into a jar every night.  You will be surprised how much you will come up with in a month.
  4. Buy your groceries at the big warehouse clubs.
  5. Have your friends or neighbors over for dinner instead of going to a restaurant.
  6. Walk or bike for any short trips – at today’s prices for gasoline, $6.45 is less than 2 gallons of gas.
  7. Check the tire pressure in your car tires and change the oil at regular intervals – better mileage equals less gas, less wear and tear on the car, etc.
  8. Change to a better cell phone plan.
  9. Only get the newspaper on the weekend when you actually have time to read it.
  10. Bundle your cable, internet and phone service.
  11. If you are in the market for a new car, get a Hybrid, save on gas AND do something good for the environment.

Impressive Math

In 20 years when the loan is paid off you will have $1228.65 a month “left over” in your budget.  Well, you could throw one heck of a party every month…or you could set that money aside in savings.  And if you did, assuming you could get just a 6% annual return you could have an account valued at $201,350.36 at the end of the next 10 years.* (not accounting for any taxes, fees etc. on your investment account).

So let’s think about it.  You could do a 30 year fixed and payout $372,668.40 over the term of the loan and have a home valued somewhere in the neighborhood of $465,000 (assuming 2.5% appreciation per year)…or…you could do a 20 year loan, paying out $294,876.00, have a home valued at $465,000 AND potentially have a savings account worth approx. $200,000.  And you would have accomplished this in the same amount of time that it would have taken to pay off the 30 year loan

The Bottom Line

In this economy it is more important than ever that we make great financial decisions and this usually requires a little homework, so the next time you are considering a 30 year mortgage, do yourself a favor and see if you can find a way to do a 20 year fixed. It is not sexy, but you will be happy later when you are counting the money you didn’t think you had.

 * check with your trusted financial or tax professional regarding tax deductibility, fees and returns associated with investing.

John King of MyMortgageBanker.com takes a consultative approach to mortgage lending and educates his clients about all possible mortgage options.