I’m going to attempt to answer the age-old question: 15 vs 30 year mortgage: which is best?
And I hate to break this to you, but it all depends (and I’m not even going to mention taxes here).
I want to start off with a table (it’s the accountant in me) outlining some basic assumptions when answering the 15 vs 30 year mortgage question. Hopefully this sheds a bit of light on these different mortagages right off the bat:
| 15 vs 30 year mortgage | ||
| 30 year | 15 year | |
| Loan: | $175,000 | $175,000 |
| Rate*: | 5.41% | 5.01% |
| Payment: | $984 | $1,385 |
| Total paid: | $354,158 | $249,264 |
| Total interest: | $179,158 | $74,264 |
* Rates taken from BankRate.com on 18 April 2005.
Alright, if you only looked as far as the payment line, you might’ve received a bit of a jolt. The 15 year mortage requires you pay out another $401 per month for the life of the loan! Take a deep breath. You don’t pay anything else on the 15 year mortgage after 15 years (makes sense eh?).
If you checked out the last two lines of the table you might have received a jolt in the other direction. If you do a 15 year mortgage you will save $104,894 verses the 30 year mortgage!
Clearly the 15 year mortgage is the best option? It depends.
One thing you absolutely have to consider with the 15 vs 30 year mortgage question: opportunity cost.
Consider this: what if you did indeed take a 30 year mortgage, saving $401 in monthly cash flow, and invested that $401 each month for the life of your mortgage? If you invested it in a mutual fund earning 9% (let’s not get into a debate about potential stock market returns at the moment), that investment would grow to $734,181!
So clearly your best option is to pass up the 15 year mortgage, stick with the 30, and invest the difference in savings. Not quite.
First off, you have to remember the extra interest cost (remember, I’m not including taxes in the analysis), of the 30 year mortgage: $104,894. So you’ll need to reduce that investment amount from approximately $730k to a more appropriate $555,024.
Well, still another half million dollars makes the 15 year an inferior choice. No, not quite.
It’s not fair that you can invest the difference in savings for those 30 years without looking at the 15 vs 30 year mortgage question from a different angle. If you take the 15 year mortgage, you’ll have that entire payment available for investment once you’ve paid off your house.
So, in actuality, we need to compare the two side by side. Taking the 30 year mortgage allows you to save $401 for the life of the loan. If you take the 15 year mortgage, you’ll not save anything for the first 15 years, but then you’ll have $1,385 to invest for the last 15 years. What does that investment equate to? Again, using 9%, $1,385 invested monthly for the second 15 years results in a value of $524,017. Does that mean the 30 year mortgage is about $30,000 (555,024-524,017) better? Nope. You’ll need to take the interest cost out of the 15 year mortgage value just as you did with the 30 year. With this analysis, the 30 year mortgage outpaces the 15 year mortgage by $105,271.
Ah ha! Clearly the 30 year mortgage is the best choice for your finances. Um, maybe.
We have assumed a 9 percent return on your investment of that $401 monthly savings. What happens if the actual return were only 5 percent? You would lose money. I used Excel’s “Goal Seek” tool to give me the required rate of return that $401 monthly investment would need to make someone indifferent (meaning you would break even) with the 15 vs 30 year mortgage question. The break-even rate of return is 7.82 percent. Basically, you would need to make sure you had a return 2.41% above your 30-yr fixed rate (assuming these BankRate.com numbers of course) to make sure you at least broke even. Any return below that and you would have been better off with the 15 year mortgage.
But we really should slow down and take a look at the personal side of personal finance. We really should be talking a lot more about peace of mind and a lot less about the numbers.
Consider this question: How much is your peace of mind worth? I personally believe one derives a lot of peace of mind from being debt free (I am completely debt free by the way). Is your peace of mind worth $105,271 over a 30 year period? Maybe I should break that down a bit. Is your peace of mind worth $292 per month? What I’m trying to get at here is this: to be debt free is something quite out of the ordinary – quite extraordinary in our day. The 15 vs 30 year mortgage question should be answered considering your peace of mind.
Honestly answer these questions:
1. Would you really invest that $401 savings?
2. Do you feel certain that if you did, your money would give you a return greater than 7.82 percent?
3. How would it feel to be completely debt free?
I ask you these questions because I think these answers will ultimately help you find the answer to the 15 vs 30 year mortgage question. If you answered “No” to question one or two, then I strongly encourage you to choose the 15 year mortgage. It guarantees you get out of debt in 15 years.
I personally have chosen to be debt free. It’s worth it!
Jesse,
Most intelligent article I have seen on the topic. Most people simply ignore the fact about the investment potential of the montly payment saving of the 30 year loan.
Regards,
Vijay
Thanks for an interesting and detailed analysis. Gave me much to think about. One intangible that I think could be added here is the intention to live in the house for the length of the loan. I’m currently weighing these options for a house that i’m likely to live in for 10 to 12 years before retiring to my villa on the beach (or my row home in detroit, depending on those assumptions)
For me, peace of mind is a mortgage payment that i’ll be able to make every month and have money left for fun and investment.
Again, thanks for the brain food!
In my situation I would go with the 30 year mortgage. Let me explain my reasoning.
1. I believe that the dollar will continue to degrage more and more rapidly in response to the current circumstances we have in the usa (Ben Bernanke believes in very loose monetary policy and will continue to devalue the dollar by printing money thereby decreasing our debt load)
2. If rapid inflation does occur then today’s dollars will be much more valuable than future dollars. This type of environment is good for debtors and bad for creditors.
3. With the extra money I will be receiving per month this will help me qualify to buy other investment properties. Also the extra cash flow will allow me to save faster for a downpayment on a new investment property.
In short, as long as I can buy properties that can easily be rented out for more than their monthly costs I believe it is advisable to buy as many properties as possible in the current conditions with low interest rates and low prices. This guards against inflation because the value of the house will increase with inflation and you can increase rent to follow the path of inflation.
I would be interested in hearing other people’s opinions on this idea.
Thanks,
Matt
I was searching the internet for an answer to the 15 vs 30 year mortgage. We are now faced with the decision whether or not to pay an extra $500 a month on a $350,000 mortgage to be debt-free in 15 years. If we went with the 30 year we are definitely the type of couple to invest the $500 but the last question solidified it for us. How would it feel to own our home in 15 years. It would feel GREAT. After reading your post we made our decision. We will choose the 15 year option for many reasons, the most being the debt-free peace of mind.
Thanks for the insightful article!
Mark
Jesse,
Reading your article gave me a peace of mind! Thank you for your detailed and thorough analysis!
Laura
Everybody here is wrong. Do the 30 year and simply send an additional $401/month that will be applied directly to principal. The loan will still be paid off in 15 years and you will have saved thousands in interest over the 15 year loan (assuming the difference in rates isn’t significant). End of story.
The rate difference can be (and almost always is) a significant savings. When we purchased our home (years after writing this article), I went with a 30-year for the flexibility and we just used some discipline and paid it down faster. The interest savings wasn’t worth the flexibility to me.
What so many fail to see with their comments is the problem with selling a home before the loan is satisfied. See how much better off you are if you had a 15 year loan vs. a 30 year loan. If you live in a house for 10 years and then sell it you have hardly any equity with a 30 year loan after 10 years. You almost have the house paid off after 10 years with a 15 year loan. If you had a 15 year loan you would take your equity and buy a new house and get a 10 year loan or another 15 year loan the next time. People who use 30 year loans (using your $175K scenario) have $31,000 in equity after ten years. That does not even cover the 20% down payment. You did not even consider MIP or PMI in the equation either.