Mortgage Term Return on Investment

Return on Investment

I’ve been digging into what profit really means – and how to use it to make and evaluate personal financial decisions.

One financial decision that has impacted our lives greatly over the last few years was to change our mortgage from a 30yr to a 20yr and then a few years later to a 10yr mortgage.

At the time I looked at total interest paid over the life of the loan and the increase in principal payments over the short term to justify the significant increased risk of tacking a much larger house payment onto our budget, not to mention the discomfort of having to postpone some purchases and adjust our lifestyle to accommodate the larger house payment. In the end I really wanted to have the 15 year mortgage, and that helped push me over the edge to take the plunge.

I made this change a few months before I was married, and my wife at the time was not excited about it. She had lived with a very tight budget for many years prior to our marriage and was looking forward to having some more breathing room in our budget. I had spent a lunch discussing the decision with my father, who agreed with my logic that having a lean budget early on in marriage would be good for us and would teach us to manage our money well and this would pay off for the remainder of our marriage and eclipse any suffering that might occur.

I myself became frantic that I had made a poor decision when my wife gave me the wonderful news that we had accidentally become pregnant on our honeymoon, and then again later on when we found 2 heartbeats in her womb and spent an entire day in quiet reflection realizing our lives would change significantly in 8 months.

Now – 5 years later, looking at moving in the next year or so – I’m so glad we suffered through this. It taught us to budget intentionally and communicate about our money. These skills will follow us through our entire marriage and I now believe the financial discomfort was good for our marriage.

Discussing with a coworker at a previous job his advice was as follows: “There’s something about a 15 year mortgage, you have to pay it off in 15 years.” It’s easy to think that you can just get a longer term mortgage and pay extra down on it, but life happens and you will not. You can easily say the same argument the other way of course, and if you do take the plunge and refinance to a lower term mortgage life will most certainly happen and you could risk having to refinance back to a 30 year loan and pay closing costs again, or potentially having to sell a house you can no longer afford or make other dramatic decisions to make ends meet when life happens.

This is why I would not recommend this to a friend, you have to evaluate the risks and rewards yourself and make the decision. For me, it worked – but it might not work so well for everyone and it could have easily caused us significant problems financially if certain things hadn’t worked out as they had. Now that I’ve framed the article – I’d like to get into some financial details using my actual data.

I purchased my home in July of 2008 for $173,000, at the time I secured a 30yr loan @ 5.5% interest and thought myself one lucky man. This meant I had a monthly payment of $983 with $189 going towards principal monthly. I kept this mortgage for 28 months, paying a total of $29,470 towards the mortgage and only reducing the balance by $6,075. So over 28 months my net worth increased by $6,075. A monthly net worth increase of $217.

I re-financed to a 15 year mortgage on 12/1/2010 at 3.75% interest with a remaining balance of $170,850 after closing costs were included in the loan. Starting out $709 out of a total payment of $1,243 went towards principal. I kept this loan for 43 months, paying a total of $53,426 towards the loan and reducing my balance by $32,555. A monthly net worth increase of $757

For your information there were some circumstances involving home insurance and escrow that made the 3^rd refinance seem like a good idea.

On 8/6/14 I refinanced again to a 10 year mortgage @ 2.75% interest. I had a remaining balance of $140,000 at the time and $1,015 out of a total payment of $1,336 went towards the principal. I’ve kept this loan for 25 months so far and have paid a total of $49,423 and reduced the loan balance by $26,083 with an existing balance today of $114,989. A monthly net worth increase of $1,043.

Obviously making this decision based solely on net worth increase is an easy decision if you have enough fluff in your budget to pull it off. I’d like to explore this a bit more and better understand how to balance the required investment vs potential return here.

Let’s pretend there are 3 options to borrow $173,000 on a home and we plan to sell the home after 5 years for $250,000. We will also plan to spend $30,000 on various improvements and maintenance to the home while living there:

Option 1: 30 year mortgage with 5.5% interest

Monthly Payment: $982.27

Initial Principal Portion: $189.36

Total Interest Paid (over 5 years): $45,893.34

Total Payments: $58,936.50

Average monthly increase in Net Worth over 5 years: $217.38

Average Increase in Net Worth / Total Payment: 22.1%

Total Investment: $88,936.50

Total Return: $90,043.16

Total Profit: $1,106.66 (1.24% of investment)

Total Profit / 5 Years (APY approximate): 1.24% / 5 years = .25% / year

Option 2: 30 year mortgage with 5.5% interest (Pay it off as a 10 year)

Monthly Payment: $982.27 + $895.23 extra payment to pay off in 10 years = total $1,877.50

Initial Principal Portion: $1084.59

Total Interest Paid (over 5 years): $37,942.97

Total Payments: $112,650.28

Average monthly increase in Net Worth over 5 years: $1245.12

Average Increase in Net Worth / Total Payment: 66.3%

Total Investment: $142,650.28

Total Return: $151,707.31

Total Profit: $9,057.03 (6.35% of investment)

Total Profit / 5 Years (APY approximate): 6.35% / 5 years = 1.27% / year

Option 3: 10 year mortgage at 2.75% interest

Monthly Payment: $1,650.61

Initial Principal Portion: $1,254.15

Total Interest Paid (over 5 years): $18,467.40

Total Payments: $99,036.65

Average monthly increase in Net Worth over 5 years: $1,342.82

Average Increase in Net Worth / Total Payment: 81.4%

Total Investment: $129,036.65

Total Return: $157,569.25

Total Profit: $28,532.60 (22.11% of investment)

Total Profit / 5 Years (APY approximate): 22.11% / 5 years = 4.42 % / year

As you can see the 10 year mortgage option yields an APY of roughly 4.5% which is decent - and will steadily hammer an increase in net worth over the life of the loan. This data makes it much easier to stomach discomfort associated with a shorter term loan, and might even persuade me to buy less house with a shorter term loan because of the difference it makes on my monthly net worth increase.