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40 year mortgage & other exotic loans

by sfishome on June 17, 2006

I just saw a quote from a lender I work with showing the difference between a 30 year and a 40 year fixed rate mortgage. I was a bit surprised that on a $500,000 loan at 7% you only save $219 per month. What that means is you can afford $33,000 more loan by going with the 40 year fixed. If you’ve got $100,000 in cash for a downpayment, and can purchase either a $600,000 or a $633,000 Condo, that really isn’t that much help.

On the other hand, why not get a 40 year fixed? Chances are you won’t be in your Condo for all 30 or 40 years. Many people want to pay down their mortgages as quickly as possible so that they can own their home free and clear. This would be a nice thing to have, but then again, even our current 7% mortgage interest rate is extremely low historically. You also get the benefits of “leverage”. If your $600,000 condo increases in value by 5% you’ve generated $30,000 in new wealth. If you only have $100,000 invested in the condo that is a 30% return on your investment. If you knew you could pay 7% interest to generate a 30% return, you’d do it in a second. If you’ve paid off your condo and own it free and clear, you generate the same $30,000 but it’s only a 5% return and you’ve got a full $600,000 tied up in your home that can’t be used in other investments elsewhere.

So I like the 40 year fixed loan. What has changed is that I’m not as much of a fan of the interest only ARM’s. Many “experts” think these were always bad loans. But if you got a 10 year fixed ARM and sell in 5 years, you never face the dreaded adjustable years of your mortgage. Last year you could save 2% or more in interest between a ARM and a fixed rate loan. Now the difference is a 0.3% or 0.4%. That is only $126 monthly difference. Of course you also get the added benefit of not having to pay the principle in the interest-only ARMs. That’s just over $400 on a $500,000 loan.

So instead of being able to afford a $600,000 property with $100k in downpayment you can now afford a $700,000 condo. This DOES make a difference. After 5 years of paying interest only vs. a fixed rate, its $35,000 in principal, or $98,000 over 10 years. So is it worth being able to afford a bigger, nicer place and trust that your property will appreciate enough to make it worth it? That’s a decision only you can make.

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