The following outlines two scenarios. One involves borrowing $100,000 for 30 years, and the other for 15 years. The point is to show you how much more powerful your dollar will be if you go with 15 years, even if the payment is a bit higher. This should help you determine the amount of home that you can afford.
$100,000 borrowed for 30 years at a fixed rate of 4% will cost you $477.42 per month, not including mortgage insurance nor property taxes. At the end of the 30 years, you will have paid $71,869.51 in interest making the total cost of your home $171,869.51.
Now, if the same amount was borrowed for 15 years at 4%, your monthly payment would be $739.69 not including mortgage insurance nor property taxes.
HOWEVER, at the end of the 15th year, the total amount of interest paid to the bank will be $33,143.00. That’s a savings of $38,726.51, and your total cost to own your home free and clear would be $133,143.00.
Just to put that into perspective, if you were to invest $38,726.51 in good growth stock mutual funds for 30 years at an average of 10% annual growth (yes, it’s possible), it would grow to a staggering number: $768,233.08.
A common argument would be to go with a 30 year fixed rate loan and put the difference of the monthly payment savings ($739.69 – $477.42) which is $262.27 into a retirement account. The results, after 30 years, would also be a big number, but not as big: $597,799.17.
The flaw in this thinking is that nearly nobody in our current culture has the discipline to save like this. So it’s likely that you’d spend the money, rather than save.
By choosing a 15 year fixed loan, your payment will be higher, OR the mount of house that you can buy will be lower. Start by dividing your NET take home pay (what you get out of your paycheck) by 4. This represents the payment that will become the best case scenario for your house. Once you have that number, you’ll know, based on a 15-year loan, how much of a home you can buy.
Let’s say you take home $2000.00 per month, after taxes. This means that you can afford a payment of $500.00 per month. If you think you can afford more, then you’re sacrificing other important areas of your life. That’s another topic for another day.
Based on $500.00, at today’s rates, if you go with a 15 year fixed rate mortgage, you can afford a $57,000 home, give or take. Don’t compromise all of the other areas of your life in order to buy a house that’s too much to handle.