Personal finance guru Dave Ramsey is famous for his no-nonsense advice, and also for his insistence on avoiding debt.
The millionaire advisor started his finance journey at the bottom. He filed for bankruptcy at just 28 years of age, and since then, he’s built an empire advising everyday Americans on how they can ditch their debt and make their first million.
Recently, he’s come down hard on 30-year mortgages, offering an in-depth look at how a longer mortgage term can see you paying thousands more in interest than if you choose a 20- or 15-year term. He warned readers of his blog strongly against taking a longer mortgage simply to make monthly payments smaller.
In his words, “Sure, the 30-year plan gives you a smaller monthly payment. But this longer, drawn-out repayment plan has more of your money going toward the interest each month — which also makes the principal balance go down much slower.”
A mortgage is an amortized loan, or one where you make a scheduled payment (typically each month) and this payment is applied to both the principal of the loan and the interest that accrues. The payment goes to the interest first, and anything remaining goes towards the principal. This can mean that a smaller monthly payment will see you paying mostly interest, rather than paying down your principal.
To demonstrate the difference between a 15-year mortgage and a 30-year, let’s take this example.
Say you have a $1,000,000 mortgage on your home and you’ve put 20% down, or $200,000. At a 7% mortgage rate, if you choose a 15-year term, you will pay $8,932.49 per month and your interest payments over the life of the loan will be $329,653.94.
By contrast, on a 30-year mortgage, your monthly payments will be $6,586.03 and you will pay $580,894.27 in interest. In other words, the extra 15 years will cost you an additional quarter of a million dollars — $251,240.33, to be exact. That’s a quarter of the value of your home, and a serious amount of cash that could be put towards your retirement savings, your child’s education or making improvements to your home.
Ramsey advised his readers to create their own amortization schedule to ensure they have a clear view of how a long mortgage could see them throwing money away.