Shorter mortgage or lower monthly bills?

Jennifer writes in:

"My husband and I are shopping very seriously for houses right now. We will likely be in a home by the start of the summer.

I’m writing to you because we’re very unsure about the mortgage. On paper, it makes complete sense to get a fifteen year or even a ten year mortgage. We will pay far less interest over the long run that way.

But then we look at our monthly bills. If we get a ten or even a fifteen year mortgage we will have some enormous monthly bills for the next decade. This will leave us a lot less breathing room each month than the bills for a thirty year mortgage would give us.

It seems like financial sense is pointing us in two different directions."

That’s because financial sense is pointing you in two different directions.

There are really two different schools of thought on this issue that you describe.

One of them focuses heavily on net worth as a financial measure. This focuses on maximizing the gap between what you spend and what you earn over a very long period of time – say, thirty years.

The other focuses heavily on cash flow as a financial measure. This focuses on maximizing the gap between what you spend and what you earn over a much shorter period of time – say, a single month.

The problem is that the only way to know which path is absolutely right is to be able to see the future. If everyone could peer into the future and know when all of the big unexpected events were going to hit their life, then they could focus almost entirely on net worth with just a bit of flexible planning to make sure that those big events were handled well.

We don’t have that crystal ball, though. We don’t know when we’re going to face a job loss or a dehabilitating illness or injury. When those types of things happen, you’re much better off with cash flow rather than a path leading to net worth.

If you could know that nothing severely bad was going to happen in the next ten years, then you would be a fool not to get the shortest possible mortgage. If you could know that several bad things were going to happen over the next decade, you’d be a fool to get the mortgage with the highest monthly payments.

Obviously, a balance between the two is best, and it’s that balance that leads to advice like keeping one’s mortgage payments to within 28% of one’s monthly income, for example. A cash flow focus would push that lower, and a net worth focus would push that percentage a bit higher.

One important thing to remember is that once you’re past the first five years of your mortgage, you’re somewhat out of the “danger zone.” You’ll have equity in the house and be able to sell it with some financial return.

So, what should Jennifer do?

If I were her, I’d actually examine many of the non-financial elements of my life. Do you have dependents? Do you have a strong family network around you? Is your job highly secure – a government job, for example? Do you have a lot of professional contacts that could easily be tapped to find more work in a pinch? Are you self-reliant and willing to do things like repair your own home or car or plant your own garden? Are you in good health? Are your dependents in good health?

The more secure those elements of my life are, the more I would lean toward the shorter-term mortgage – a net worth based approach, in other words. The less secure those elements in my life are, the more I would lean toward the longer-term mortgage – a cash flow based approach, in other words.

Personal finance is a whole-life concern. It’s not just about dollars and cents. The relationships you have, the career you’ve chosen, your health – they’re all factors.