Whenever I make calculations on this site, I usually involve some calculation in which a person contributes some dollars a month each month to savings in order to make an even comparison of which option is a better deal. Quite often, to the chagrin of my readers who are looking for a “deal,” I recommend the solution with the higher monthly payments.
On a fundamental level, most of us strive for lower financial requirements each month so we have more money to “play” with. The truth is, though, that people we are indebted to are going to want to get their money back with interest, and the longer you keep their money, the more interest you’re going to pay on it. Thus, smaller monthly payments in fact mean that you pay significantly more in the long run.
Even given that, many people argue that this can be recovered if you simply save the difference between the lower monthly payment and the higher one, and thus they use that to justify a worse deal. There’s a big problem with this plan, one that I don’t usually discuss, and that is human nature.
On a monthly basis, almost all of us pay our required bills and then spend what we have left. Even though we “promise” ourselves that we’ll save some, the majority of Americans simply do not, even though it’s incredibly simple to do with automatic deductions and the benefits are quite clear. In fact, many people actually start off saving diligently, but after a month or two, “something” comes up, the savings plan goes in the trash, and you’re stuck with a payment plan that costs you extra money in the long run.
Whenever you evaluate a loan payment, ask yourself honestly how likely you are to actually save the difference between the high and low payments based on your past performance. This is risk evaluation at its most simple: are you a risk? If you’re not wholly confident of your ability to save that difference, then quite often you should go for the higher payment? Why? You’re making that difference a requirement, rather than something you don’t have to do – and probably won’t.
This is why I’m planning on getting a 15 year mortgage. Not only is the interest rate lower than a 30 year, the higher payments ensure that I’ll be putting that money into equity each month instead of merely “hoping” that I’ll invest it in something worthwhile. Even though the payments are higher, I’m reducing my biggest risk element: me.