What term mortgage is best for us?

[avendesora]

I'm considering refinancing our mortgage because of better interest rates. We have a 5% now, and are considering refinancing to 4.25%. We've been in the house 7 years.

If we refi to a new 30 year fixed, then we'll be making payments until we're 62. DH loves his job and loves working, so we're not looking to retire early, so paying until we're 62 isn't necessarily a problem. Of course, I wouldn't mind paying it off sooner, of course. If we restarted the 30-year clock, we'd be paying on the mortgage for a total of 37 years.

However, our kids are 4.5, 3, and 1.5 yrs old. If we get a 15 year mortgage, we would have paid our house off in a total of 22 years, and we'd be mortgage-free when the kids are in college. Paying for college would be easier if we didn't have a mortgage, but here's my real question: Would being mortgage-free negatively effect our chances at the kids getting financial aid for college?

Would we be worse off for paying more interest than necessary by getting a longer-than-necessary loan, or would we be worse off for being ineligible for most financial aid packages?

Thanks!
Aven

[Delicateflower]

I know this isn't answering your financial aid question, but it's something it doesn't look like you've considered.

The only difference between 15 and 30 year is the minimum monthly obligation and possibly the interest rate. Provided you get a mortgage with no prepayment penalties you can pay a 30 year off in 5 year if you want to.

We will be choosing a 30 year and paying (hopefully) almost twice the 15 year payment for a couple of years, then dropping our extra payments down and should pay it off in 7-8 years. But if something happens in the meantime (from unemployment, illness, major house repairs, our car dying) we can pay just our obligation while we cover that emergency and rebuild our emergency fund, then go back to paying more when we can afford it. We would also be able to move towns and rent this house for enough to cover the mortgage with a 30 year term.

I use this calculator http://www.wikihow.com/Create-a-Mort...icrosoft-Excel

You should be able to calculate any extra cost because of a difference in interest rate between 15 year and 30 year (paid off in 15) terms, then judge whether the flexibility of the lower obligatory payment is worth it to you.

I'll be interested to see how financial aid works. It doesn't on the face of it seems like it shouldn't make a difference whether the extra money each month for the next 15 years goes into home equity or investments. It should be a parent's net worth = x, income =y, financial aid = z type of deal, shouldn't it?


PS: I think I'm mortgage obsessed, please forgive me for posting on every mortgage thread for the past month!

[avendesora]

Another thought I have, in favor of my 30 (actually 37) option, is that 4.25 is so low! that savings rates will be higher than, on average, over the next 30 years. Would I be better off putting my extra $500/mo into savings instead of paying down the mortgage early? For example, I'll save $78,000 in interest by paying in 15 years instead of 30. But I could very well earn $78,000 in interest by putting $500/mo into any decent fund.

I'm thinking out loud here, please tell me if I'm correct about this:

Two 30 year scenarios, both involving me paying out $1414/ mo for 30 years.

A. 30 year loan. Pay $924/mo to the mortgage and save $490/mo.
If I can save at 5% my final account balance will be $401,161.

B. 15 year loan. Pay $1414 to the mortgage for 15 years, and then pay $1414 to a savings account for 15 years.
If I can save again at 5%, my final account balance will be $375,987.

And, I think 5% is pretty modest when thinking long term. Markets are down terribly now, but interest rates will go up again eventually...

But I'm also really curious about that mortgage vs. financial aid thing

Thanks!
Aven

[polyhymnia]

Originally Posted by avendesora

Another thought I have, in favor of my 30 (actually 37) option, is that 4.25 is so low! that savings rates will be higher than, on average, over the next 30 years. Would I be better off putting my extra $500/mo into savings instead of paying down the mortgage early? For example, I'll save $78,000 in interest by paying in 15 years instead of 30. But I could very well earn $78,000 in interest by putting $500/mo into any decent fund.

I'm thinking out loud here, please tell me if I'm correct about this:

Two 30 year scenarios, both involving me paying out $1414/ mo for 30 years.

A. 30 year loan. Pay $924/mo to the mortgage and save $490/mo.
If I can save at 5% my final account balance will be $401,161.

B. 15 year loan. Pay $1414 to the mortgage for 15 years, and then pay $1414 to a savings account for 15 years.
If I can save again at 5%, my final account balance will be $375,987.

And, I think 5% is pretty modest when thinking long term. Markets are down terribly now, but interest rates will go up again eventually...

But I'm also really curious about that mortgage vs. financial aid thing

Thanks!
Aven

You know, it's been so long since I filled out a FAFSA that I don't remember exactly what they ask. Why don't you search online for the FAFSA website and print out a copy of the form, then see what exactly it asks for? I know it is based on your prior year's taxes but it also asks about assets so I am not sure what effect the house would have.

[Delicateflower]

Originally Posted by avendesora

Another thought I have, in favor of my 30 (actually 37) option, is that 4.25 is so low! that savings rates will be higher than, on average, over the next 30 years. Would I be better off putting my extra $500/mo into savings instead of paying down the mortgage early? For example, I'll save $78,000 in interest by paying in 15 years instead of 30. But I could very well earn $78,000 in interest by putting $500/mo into any decent fund.

Yes.

I am such a geek, I actually looked up the 2009/10 FAFSA. And it seems like it is best to have the money in the house, not the bank. But that's just me reading the form.

• Investments include real estate (do not include the family home), trust funds, UGMA and UTMA accounts, money market funds, mutual funds, certificates of
deposit, stocks, stock options, bonds, other securities, Coverdell savings accounts, 529 college savings plans, the refund value of 529 prepaid tuition plans,
installment and land sale contracts (including mortgages held), commodities, etc. For more information about reporting educational savings plans call
1-800-4-FED-AID. Investment value means the current balance or market value of these investments as of today. Investment debt means only those debts that are
related to the investments.
• Do not include the value of life insurance, retirement plans (401[k] plans, pension funds, annuities, noneducation IRAs, Keogh plans, etc.) or cash, savings and
checking accounts already reported in questions 41 and 91.
• Business and/or investment farm value includes the market value of land, buildings, machinery, equipment, inventory, etc. Business and/or investment farm debt
means only those debts for which the business or investment farm was used as collateral.
As of today, what is the net worth of your parents’ investments, including real estate (not your
parents’ home)? (Q92)
As of today, what is your parents’ total current balance of cash, savings and checking accounts? (Q91) $

[TiredX2]

Originally Posted by avendesora

But I'm also really curious about that mortgage vs. financial aid thing

As you saw above, putting money into your *mortgage* is better for financial aid than putting it into savings.

That said, if you haven't maxed out your retirement savings (work & IRAs) then you could put your investment money there (instead of the mortgage) and have it not be considered by the FAFSA.

[SeekingJoy]

If you are going to refinance regardless, what is the interest rate on the 15 year loan? Is it that much lower than the rate on the 30 year?

[avendesora]

Both the 30 and 15 have 4.25%, however, the points required are different. 2.750 points for the 30 and 1.875 points for the 15, which is a difference of only $1,645 at closing. That's not much, relatively speaking. Maybe that answers my question right there.

[SeekingJoy]

I would get the 30 year, pay it off at the higher level of payments until the interest rate in a high-interest savings account gets over what you can get currently (<2% for everything I have seen), then you can drop back to the lower level of payments.

Your assumptions above are based on a high interest rate in savings accounts, which will likely happen sometime within the next 30 years, but who knows when. Better to go with the current rate environment and leave yourself the flexibility to change course as you need to.

[nd_deadhead]

In order to make a consistent comparison, you need to extend all of your scenarios out 30 years from today. One thing you didn't consider is that when your current mortgage is paid off, you can invest that payment (I think it's around $1147?) for 7 years, earning 145,902 at 5%. You also could invest the difference between your current morgage and the 15-yr payment - about $266/month. This would earn you $96,340 in 30 years.

The other thing you didn't consider is whether you itemize your taxes, and deduct your mortgage insurance - which makes your actual interest payment less. And of course you have to subtract the amount of interest you paid in each case from your final balance. You also need to deduct the amout of closing closts (to be totally fair to each choice).

Here's what I came up with:

Current mortgage: pay $128,743 in interest (for the next 23 years)
Invest that payment for 7 years at 5%, totalling 145,902
Invest $266/month for 30 years: $96,340
Net balance: $113,500
BUT if you deduct the interest, and are in the 25% tax bracket, your net in 30 years is $145,685

Refi at 30 years: pay 145,255 in interest
Invest $490/month at 5% totals 407,807
Net balance: $262,552
BUT if you deduct interest, your net balance is $298,866

Refi at 15 yrs: pay $65,591 in interest
Invest 1414 for 15 years: total $377,947
Net balance: $312,356
Net balance if you deduct interest: $328,754

But there are so many unknowns. If you DO, in fact, invest the difference, then refinancing is the way to go, because you are increasing the amount you can invest right away. And of course if interest rates fo up, the sooner you can take advantage of that, the better - which could make the 30-yr refo the best option (since you don't start investing for 15 years in the 15-yr-refi).

If interest rates stay low, and you can't earn more than you're paying, then make extra payments to the mortgage.

BUT if something comes up in the future, and you don't make those investments - someone loses a job, or you have large unexpected expenses (a medical emergency, for example), you are better off with your current mortgage. It gives you a lower payment than the 15-yr refinance (which is a cushion for unforseen expenses), and costs you less in inteest than a new 30-year mortgage, even at a lower rate.

It all boils down to your risk tolerance.