Beware short term gains you might make by having a shorter term and lower repayment
There are many considerations when choosing the right mortgage, but one that is often overlooked, and is probably more important than all others combined, is the term of your mortgage.
The majority of people I come across, particularly first time buyers, don’t look at the long term savings. They find it hard to get past comparing one monthly repayment against another, and the reason is they don’t know what they don’t know.
I believe getting people’s attention begins with making that connection between their present and future selves and doing so in a way that is relatable and makes sense to them.
So, I start off by looking at a mortgage term, which is half the term they were considering. It doesn’t matter for the time being whether they can afford the monthly repayment or not. I want to alter their fixed mindset of choosing the longest term possible for a moment.
Imagine for a moment you are 30 years old, and you borrowed €250,000 and chose a 15-year term, instead of 30. What impact would that have on you now and in the future?
It’s a big question, and I’m not sure if many people put much thought into it. Even if they did, what are they looking for? What’s their starting point?
The first is obvious enough; you don’t need me to tell you you will be mortgage -free twice as fast but let’s make a list of numbers they should know about.
The differences between a 15 and 30-year mortgage are (a) the monthly repayment and (b) the total interest paid. With a shorter term, your monthly repayments will be €670 higher.
But with a shorter term, you’ll pay €72,745 less back in interest.
The cost of servicing a mortgage over a 15-year period is c. €32,207. That’s the gross amount you’ll need to take from your salary every year to pay for it. But, when the mortgage is cleared, that’s €32,207 you don’t need to earn anymore, meaning you can pivot and change careers, or you could earn or work less if you wanted to because you have no mortgage repayment to worry about.
The age you will be mortgage-free. If you go for a longer term, you would be 60 before you own your house outright.
The amount you would add to your pension/savings fund, for those 15 years you aren’t paying a mortgage anymore.
The extra amount you would be in receipt of each year in retirement, from diverting the amount you had previously being paying on your mortgage, to your pension/savings funds.
The difference between what you owe in year five, based on a 15 and 30-year term. With a 15-year term, you could absorb a drop in value by €51,250 and still have a loan-to-value (LTV) of 80% allowing you to move properties if you wanted to.
If you chose a 30-year term, in year five you still owe €222,869 and if the property fell in value by €51,250, you would still owe 100% of what the house is valued at. So, if you wanted to move, you’re going nowhere for at least 12 years until your loan balance was 80% of the value of the property.
This is the number of hours you would save from not having to work to pay your mortgage, if you chose a lower term.
A gross income of €71,500 is required to qualify for €250,000 using current 3.5 times income multiple. That means your net annual income is about €47,809. If you work 40 hours per week over 12 months, your hourly rate is €29.98.
The total interest paid for a 30-year mortgage term is €136,763 meaning you have to work 4,562 hours to pay for it. Over 15 years, the total interest paid is €64,018 which is 2,135 hours.
The difference between the amount being applied to the amount owed in year one. With a 30-year mortgage, only 39% of your monthly repayment is going towards reducing the capital, but with a 15-year term, 62% is.
If you are in that mortgage process or are about to embark on it, my advice is to look beyond the monthly repayment and try to see the bigger picture. It’s easy to show how good it is to choose a shorter term, but it does come at a price. The term you choose will depend on your personal situation and a shorter one can be the right choice for some, if not for others. But when choosing the term of your mortgage, the key is to take your time, don’t let yourself default into the longest term possible.
Evaluate your finances first and look at all options and know the impact they can have on your financial situation now and in the future.
Liam Croke is MD of Harmonics Financial Ltd,
based in Plassey. He can be contacted at email@example.com or www.harmonics.ie