Many of our clients think they need to get a 30 year conventional loan because they cannot run the risk of getting an ARM. The truth is that each client must carefully evaluate their loan options because in most cases, the 30 year loan is not the best option for them. In other cases, there are some excellent options with the security of 30 year fixed loans, but with a 10 year interest-only option, where you are only paying interest for the first 10 years.
If you are going to live in your next home for the next 30 years, then it’s very possible a 30 year conventional loan is the best option for you, because eventually you will pay the loan off and own the home completely. However, if you are going to live in your next home for, say, 7 or 10 years, what you must know is that even with a conventional 30 year mortgage, you are paying mostly interest anyway (see the graph below).
In this case, you should strongly consider an interest-only loan. Your monthly payment will be lower and you will be able to afford a larger house. By affording a larger home, it is possible, even likely, that you will end up with more equity in your home when you are ready to sell. But even more importantly, when you pay principle plus interest, you are basically putting money into your house that you'll just be taking out later when you sell the house. You're treating your house like a piggy bank. For many buyers, the emotional security of paying down their mortgage makes this worth doing, and that's fine. We just want to make sure you realize that your mortgage is likely the cheapest money you can borrow. You may want to consider paying interest only so you can take your hard-earned cash and put the difference in another investment that will return more than the interest rate you're paying on your loan.
A sample transaction: Joe vs. Jane:Jane can afford $2,400 per month. She gets a 30 year conventional loan and buys a home for $400,000, and owns the home for seven years. At the end of 7 years, the home she purchased is worth $562,840. Her remaining principal balance is 360,134.28, meaning she has a total gain of $202,705.72. However, in those 7 years she’s paid $29,554.44 in monthly payments, meaning her net gain is $173,151.28.
Joe can also afford $2,400 per month. He gets a 5/1 interest-only ARM, and is able to afford a $590,000 home. He owns the home for seven years. At the end of 7 years, the home he purchased is worth $830,189.25. His remaining principal balance is $590,000, meaning he has a total gain of $240,189.25. However, in those 7 years he’s paid $38,349.96 in monthly payments, meaning his net gain is $201,839.29.
In this example, Joe has made $28,688.01 more than Jane while paying less every month.
Note: These numbers are based on a 5% yearly gain in home value. The average gain nationwide is 7% annually, meaning the difference would be even greater. However, these numbers are forward-looking projections and are in no way guaranteed. Please consult a ?nancial advisor to analyze these ?gures in more detail.