Friday, August 23, 2013

In Praise of the 15-Year Fixed Mortgage -- as Opposed to the 30

Recently there's been talk in praise of the 30-year fixed mortgage.

I teach one of the largest personal finance courses in the country at the University of Arizona and am president and founder of National Personal Finance Education, one the largest licensed providers of a personal finance course required for people in bankruptcy.

I've thought about this a lot.

My opinion on this is that usually 30 years is too long, at least for most college graduates with a decent income. And if it's a Wal-Mart worker couple, they should be very careful about buying any home they can just barely afford with a 30 year mortgage. The focus should really be about trying to upgrade their skills and education, and especially the education of their children, so as not to be a Wal-Mart couple.

Anyone who's followed my blog knows I have a lot of sympathy for the working poor. I'm a strong advocate of not only free universal high quality pre-school, but also free universal high quality bachelor's degree, or worthwhile vocational training. I favor free universal healthcare, like Medicare for all, and a stronger safety net. But a Wal-Mart couple doesn't help themselves by creating severe financial stress to just barely be able to afford a home with a 30-year mortgage. It doesn't take anything that rare or unlikely going wrong to lead to a traumatic foreclosure. Living even in a modest house can be much more expensive than living in an apartment in a comparable neighborhood; consider the mortgage, the downpayment, maintenance, property taxes, insurance, increased furniture and utilities costs, an attitude that you should spend more with a house, and more. It would be better for the kids to live in a more affordable but decent apartment complex, and have some financial security, accumulate a cushion of thousands of dollars in the bank, and to help yourselves and your kids you focus on education, education, education.

So while I think for the working poor a 30-year mortgage may be necessary -- if it is prudent and affordable to buy the home -- usually the 15-year fixed is best for the solidly middle class and college educated (and even then it's often best to make additional payments to end it even sooner). The interest rate is lower, usually by a lot; the payments aren't that much higher (due to the lower interest rate and the surprising exponential nature of compound interest over long periods of time – Try comparing the monthly payments and see.), and it's so valuable with the country so financially insecure for families to get to no mortgage as quickly as possible. Elizabeth Warren in her seminal personal finance book, "All Your Worth", rightly stresses the great importance of getting your "Must-Haves" (basically fixed expenses) low in today's dangerous America, and having no mortgage is a great way to lower your Must-Haves. Get some solar panels (in the right area with the right tax spiffs), and now you have little or no utility bill too.

Life, especially today, gets a lot riskier as you get older. At 25 you might have super health and resilience and no dependents, and be able to live happily and healthily on nothing, eating macaroni and cheese, sleeping on a futon, and driving a beater. That becomes way harder when you're 45, with kids. And if you lose your job at 45, it will be a lot harder to find one close to as good, or good enough, with age discrimination, declining health and energy, and perhaps antiquated, or rapidly antiquating, skills. 45 is a really good time to have no mortgage payment, as opposed to not until 60.

In addition, as usual, positional/context/prestige externalities are profound and huge. When a family thinks 15-year mortgage, they are likely to buy a smaller home, not get so much wood, granite, and stainless steel, buy less large and expensive vehicles, etc. But because they get used to that level -- and don't start getting used to a higher level of position, prestige, etc., the decreased utility is not that much, and the increased security of having no mortgage right when the kids are setting off for college can be huge. And how important it is for kids to be able to go to college without having to flip burgers 20-40+ hours per week, a great advantage for graduating, GPA, and learning. And in any case, the buying a smaller home, cars, etc., can mean that total payments aren't even higher.

Interestingly, given the ginormous importance of positional externalities, if the government nudged forward 15 year mortgages, you might see people commonly owning their own homes twice as quickly with little loss of utility, as you wouldn't lose position, prestige, or context of quality if everyone else was also doing 15-year mortgages and so they also had commensurately less to buy a home with.

Of course, we'd also have to control home equity predators from undoing this.