What’s the best type of mortgage to obtain? What should you avoid? What are your mortgage options, exactly?
We find that clients have certain assumptions about mortgages. “The lowest rate mortgage is always the best option.” “Always put down 20%.” “A 15-year mortgage is better than a 30-year.”
However, these assumptions are not always correct.
Let’s examine some mortgage options through the lens of Prosperity Economics—an alternative to typical financial planning. Prosperity Economics uses certain principles of prosperity to deliver better, more reliable results than typical financial advice. (Find out more here.)
When it comes to getting a home mortgage, you don’t want buyer’s regret! After all, it is the funding mechanism tied to your home AND a financial product you may have for years or decades to come. Some common mortgage options include:
The 30-year mortgage.
Your typical, popular, boring, fixed rate, conventional 30-year mortgage is actually a GREAT option! The way inflation and the time-value of money works, you’ll be amazed how “cheap” the mortgage feels several years from now.
You might be thinking, “But I’ll pay more interest with a 30-year mortgage!” That is true, but it’s not the whole story. With the lower payment (compared to a 15-year mortgage) you’ll have more to save and invest. If you are disciplined to do so, a 30-year mortgage is a better option.
The 15-year mortgage.
A 15-year mortgage typically has a slightly lower interest rate and the payments are often not that much more than the 30-year. However, the higher payment can also be more challenging if you lose a job or have other financial challenges. You’ll usually do better to stick with the 30-year and save or invest the difference.
Adjustable rate mortgages.
In this low-interest rate environment, do NOT get an adjustable rate mortgage unless you know for a fact that you will sell the home in the next year or two. Right now, fixed rates are so low there is no advantage to adjustable rate loans! But in any market, if you think you will keep the home for any length of time, a fixed rate loan is almost always preferable.
FHA or Conventional?
Conventional loans typically have the lowest interest rates, compared with other fixed-rate options. (Subprime loans are for people who don’t qualify for other mortgages and have much higher interest rates. It’s usually preferable to just wait and get qualified.)
FHA loans are easier to qualify for, credit-wise, but are unfortunately laden with fees, especially since the government got stuck guaranteeing so many failed mortgages in the Great Recession.
VA or USDA loans?
If you qualify for a zero down VA loan (Veteran’s Administration) or a nothing down USDA loan (U.S. Department of Agriculture mortgages for more rural areas and for buyers who might not quite fit traditional lending guidelines), you may want to take advantage of it! These loans have low (or no) mortgage insurance charges and competitive interest rates.
A line of credit (instead of a traditional mortgage).
In recent years a lot of “mortgage acceleration systems” have popped up that promise to help you pay your home off faster by replacing your traditional mortgage with a line of credit. These systems are misleading and don’t deliver what they promise. Worse—they can actually COST you more in the long run!
Listen to Kim Butler on The Prosperity Podcast bust this myth and explain exactly what is WRONG with these mortgage acceleration schemes.
The problem with prepaying your mortgage.
This option assumes that paying off your mortgage faster is a GOOD idea. As Jimmy Vreeland and I assert in Busting the Real Estate Investing Lies, you don’t want your wealth trapped in the walls of your home! What happens if the market drops, if the bank recalls a credit line, or if you cannot qualify for a refi or new line of credit? You lose access to that equity, or you might even lose it altogether.
Home equity is not liquid. It won’t put food on the table. And it’s not under your control.
We don’t recommend paying off a mortgage early unless it’s a “must” for your peace of mind. When you consider opportunity costs, you’re almost always better off using that money to invest somewhere else. Numerically, it doesn’t make sense to prepay a 4% mortgage (for example) when you can earn 5-10% on your money in a cash flowing investment such as rental real estate, bridge loan, peer lending or mineral rights lease.
So instead of paying down the principle on your mortgage, utilize “good debt” (your mortgage) for as long as you can—and save or invest the difference. This will make your dollars more efficient and give you assets you can use!
What about life insurance cash value?
Some people think there is a big advantage to paying off your mortgage with a life insurance loan. Unfortunately, this usually comes from the mistaken belief that you can “recapture” interest payments by borrowing against life insurance cash value. If you hear the phrase “pay interest to yourself,” beware; that’s not how life insurance loans actually work!
When you borrow against your policy, you borrow from the life insurance company with your cash value as collateral. You also pay interest to the life insurance company—not yourself! Unless that interest is lower than the interest rate you can obtain on a mortgage (right now it’s probably not), you’re better off keeping your mortgage and saving your cash value for a better opportunity.
And although it doesn’t usually make sense to finance a home with a life insurance loan, high cash value whole life insurance IS a great place to save extra dollars instead of prepaying your mortgage. The money will be available when you need it—not trapped in the walls of your house!
How big of a down payment?
Typically you’ll have to pay mortgage insurance (MI) unless you’ve saved that 20% down payment. And usually, the bigger your down payment, the less the MI is, such as 10% is better than 5%. Know that it can often be dropped in a few years… but it’s harder to get MI off FHA loans and some other loans.
While a bigger down payment is nice, if you don’t have that much saved yet, it doesn’t need to be a barrier to purchasing a home. It makes no sense to keep wasting $1500/month on rent to avoid spending $200/month on mortgage insurance.
Get the best deal on your mortgage.
The most important factors to qualify for a mortgage are your:
- down payment
- income and work history
- and credit score.
If you want to lower your mortgage payments, make sure your credit is as good as it can be. A larger down payment can help. And you’ll need verifiable income, usually three times or more the amount of the mortgage payment.
For more on getting the best deal on a mortgage loan, read “A Home Buyer’s Guide for Wealth Builders.”
See the big picture.
As you consider options, be sure to look at the big picture of your mortgage. Getting a great rate may not be so great if the mortgage insurance is sky high and the origination fees and points keep adding up. A shorter term mortgage (such as 15 years) may not be the best option after all. And sometimes “nothing down” deals or mortgage acceleration programs will cost you more than they will save you!
Always look at what a mortgage will cost you—up front and monthly. Compare your options. And be aware of anything out of the ordinary, like adjustable rates that could deliver an unpleasant surprise.
More on why we prefer a 30-year mortgage over a 15-year mortgage.
Prosperity Economics strategies go against the grain of common financial advice. But once you examine the math, you’ll understand the power of this philosophy! Whether it’s comparing mortgage options, increasing cash flow or simply gaining more control back from Wall Street, see how Prosperity Economics can help you.