The 15 year mortgage has become more popular since mortgage interest rates dropped.  An article in the Wall Street Journal gave some reasons why this is happening.

With the low mortgage interest rates, many homeowners are finding that a 15 year mortgage is more affordable than previously.  In addition, for those homeowners that have been in their house for 5-7 years, the leap to a 15 year mortgage isn’t as big of a stretch as it was then they bought their house a few years ago.

Should you consider a 15 year mortgage?

The Benefits of a 15 year fixed rate mortgage:

• Build equity in your home faster
• pay less interest
• forced savings account
• Benefit with low interest rate refinance without stretching loan term back to 30 years

The Cons:

• You have to make that higher payment each month
• A house is  a terrible place to store your wealth – better than spending, but worse than most any savings vehicle
• Opportunity cost – money used to pay down principal is money that can’t be used elsewhere
• Loss of flexibility – a future job loss or financial challenge could be catastrophic because of the higher required payment on the 15 year fixed mortgage

In some areas, a 15 year mortgage is a disaster for people – for example, someone who took out a 15 year fixed mortgage in Florida or Las Vegas in 2007 is now seeing that they send in a payment and the house price drops by more than the principal paid in.  How would it feel to send $1000 to your savings account and the next day have $0 left?  That is what many people experienced with 15 year mortgages in rapidly declining markets.

Which loan is best for you?

On the other hand, if you are in a stable housing market like Charlotte or Raleigh, North Carolina, the 15 year mortgage may not be so dangerous.  You will spend less on interest, build equity faster, and protect yourself from spending the money elsewhere – the forced discipline of this mortgage is helpful to some people.

If you have pretty good assurance that your income is going to be stable or increasing for the next several years, if you are already saving for retirement, have an emergency fund, and don’t carry other debts such as credit cards, student loans, or car loans, then you may be ready for the larger payment of the 15 year fixed mortgage.

If you have some credit card balances, don’t have several months living expenses already saved in an emergency fund, and aren’t putting away money for retirement or kid’s education, don’t get a 15 year mortgage – there are more important things to do with your money.

Before you decide to take on a 15 year mortgage, consider the best uses of your money, and make sure your new mortgage won’t prevent you from doing something more important.

If you find yourself in a situation where you have equity available in your house, and also have a bunch of other debts, such as credit cards or auto loans, you may consider refinancing and rolling the debts into the new mortgage.

Most people will tell you not to do a consolidation loan, but, like so many other things, “It Depends”. 

There is a right way and a wrong way to roll your credit cards or auto loans into your mortgage.  First, the wrong way – if you simply get a larger mortgage and spread out your payments on your 3 year old car for 30 years, you are probably making a mistake.  More importantly, why do you have the other debts?  Are they from a specific event or cause, such as a medical emergency, or are they a result of a lifestyle that consistently out-spent your income? If your accumulated debts are just a habit, then rolling all the debts into a new mortgage will likely leave you with a bigger mortgage and more credit card debt just 2-3 years later.  You will be worse off than if you never refinanced.  However, if you can point to a specific cause of the debts, and can show a track record of reducing those debts over the last 6-12 months, then you may be able to refinance and benefit from lower, tax-deductible interest payments rather than high interest rate credit cards.

The Right way to consolidate your debts into your mortgage:

First, know the reason the debts are there – if you can’t tell why you have the debts, then paying them off will not stop them from re-appearing.  In fact, you will go back into debt if you are in the habit of using credit cards to get by.

Second – know what your amortization schedule looks like.  From an amortization schedule you can see how long it will take for the added debts to be paid off.  The Amortization schedule will vary based on the term of the loan and the interest rate.  As an example, take a look at the table below.  This is for a $200,000 mortgage. 

You can’t control the interest rate – the market sets that, but you can control the term.  The real difference is with shorter loan terms – using a 20 year term pays off the $25,000 addition in just 3.8 years and a 15 year mortgage pays off $25,000 in only 2.5 years!

Third – Accountability.  If you are going to pay off debts and more importantly, stay out of debt, an accountability system is critical.  Usually this would be a financial planner or advisor that regularly reviews your finances with you.  Accountability can also come from an annual mortgage checkup with a mortgage planner.  When we review a client’s mortgage, we look at the credit report changes over the past year, the performance of the mortgage and the value of the house.  If debts are creeping back in, immediate changes need to be made to keep the plan on track.

Debt Consolidation Mortgage Power Play:

The absolute best way to consolidate debts into a mortgage is to use the shortest mortgage term possible.  By eliminating credit card payments or auto loan payments, the shorter term and higher payment of a 15 or 20 year mortgage suddenly becomes affordable.

In this example below, a client used a 15 year mortgage to pay off $28,000 in credit cards and car loans.  By eliminating the credit card and car loan payments, the borrower was able to use a 15 year mortgage and rapidly build equity in their house.

 Even is this borrower needed to finance a new car in a few years, the added equity in their house would exceed the new auto loan liability.  The usual outcome, however, is that once the habit if credit cards and auto loans is broken, a person finds it easier to save, so they are able to pay cash for future cars.

 So, before you listen to the pundits that tell you to never roll your debts into a mortgage, consider the effect of the amortization schedule, the loan term, and the reason the debts exist and make the best decision for yourself. 

This is another example of why I tell people to “Start with the House” to reach financial freedom.  If you have  a sound plan for consolidating debts into a new mortgage, you can build wealth and find yourself debt free faster.