Mortgage term - Which is right for you?
The Present Value of a mortgage with a mortgage term of 30 years, with repayments of $1074 at a 5% interest rate is $200,066.
The Present Value of a mortgage with a mortgage term of 20 years, with repayments of $1320 at a 5% interest rate is $200,066.
The two repayment schemes are exactly equal.
The $69,756 'saving' in the interest rate is really just the effect of adding the extra $246 a month into the repayments - in fact, that $246 a month adds up to $59,040 over 20 years.
What if you took that $246 a month and invested it in, for example, mutual funds?
If you could get a return of 10% p.a., after 20 years you would have $186,804. With inflation at 3%, that would be worth $102,597 in today's money.
Why would the banks recommend that you pay off your mortgage quickly? Surely the longer the income stream lasts, the better?
The banks love being able to prove that their recommendations will 'save you money'. But in reality, the banks do understand the time value of money. They know the true value of that extra $246 a month that you're giving them now, not in the future. And the shorter the time you take to repay the mortgage, the lower their risk, and the sooner their money comes back to them to be loaned out again.
There are some arguments for paying your mortgage back quickly - for one thing, the quicker you pay, the quicker your equity grows. But you should understand that every dollar you give the bank now is a dollar that you can't invest.
Giving your money to the bank to avoid paying 5% interest means that you can't use that money to earn 10% or 12% or 15% somewhere else.