Thursday January 8, 2015
By ALICE MEEKS
One of the best ways to eliminate your mortgage debt is moving into a 15-year fixed-rate loan. With the average spread a full 1% compared to its 30-year counterpart, a 15-year mortgage can provide an increased rate of acceleration in paying off the biggest obligation of your life.
Can you pull it off?...
In most cases, you’re going to need strong income for an approval. How much income? The old 2:1 rule applies. Switching from a 30-year mortgage to a 15-year fixed-rate loan means you’ll pay down the loan in half the amount of time, but it effectively doubles up your payment for each month of the 180-month term.
Your income must support all the carrying costs associated with your home including the principal and interest payment, taxes, insurance, (private mortgage insurance, only if applicable) and any other associated carrying cost.
In addition, your income will also need to support all the other consumer obligations you might have as well including cars, boats, installment loans, personal loans and any other credit obligations that contain a monthly payment.
The attractiveness of a 15-year mortgage in today’s interest rate environment has mass appeal. The 1% spread in interest rate between the 30-year mortgage and a 15-year mortgage is absolutely real and for many, the thought of being mortgage-free can be very tempting.
Consider today’s average 30-year mortgage rate of around 4% on a loan of $400,000—that’s $287,487 in interest paid over 360 months. Comparing that to a 15-year mortgage over 180 months, you’ll pay a mere $97,218 in interest. That’s a shattering savings of $190,268 in interest, but there’s a catch...
Here’s how it breaks down. The 30-year mortgage in our case study pencils out to a $1,909 monthly payment covering principal and interest. Weigh that against the 15-year version of that loan, which comes to $2,762 a month in principal and interest, totaling $853 more per month, but going to principal.
This is why the income piece makes or breaks the 15-year deal. Independent of your other carrying costs and other credit obligations, you’ll need to be able to show an income of $4,242 a month to offset just a principled interest payment on the 30-year fixed-rate mortgage.
Alternatively, to offset the principled interest payment on the 15-year mortgage, you would need an income of $6,137 per month, essentially $1,895 per month more in income, just to be able to pay off your debt faster. As you can see, income is a large driver of debt reduction potential.
