I ran into this article about 40 year fixed rate mortgages at Bankrate.com and I just couldn’t let it slide without a bit of comment.

Okay, so people are starting to look at 40 year mortgages because they want to squeeze a few extra bucks a month off their mortgage payment. According to the article, with a $200,000 loan, you’re looking at saving on your mortgage payment less than $64.

But how much is the extra ten years going to cost? In the first five years of your mortgage (and we all know that most mortgages don’t last much longer than 5 years), you’ll pay an extra $3,500 in interest. Oh, by the way, guess how much equity you built in your house during the first five years when you elect to stay in debt for 40? $6,500. More than $7,000 less than on a 30 year fixed-rate mortgage. Sheesh, if housing happens to be somewhat stagnant, you’ll be lucky to come out even a bit ahead after closing costs.

“It allows you the opportunity to have a lesser payment, and for many people it gives the luxury of choice,” says Jim Sahnger, a broker with Palm Beach Financial Network in Sewall’s Point, Fla.

Alright, first, Mr. Sahnger is a broker. He makes money when you take out a mortgage. I can promise you that selling you a 40 year fixed rate mortgage will be much more profitable than selling the 30 year counterpart.

No conflict of interest there.

What Mr. Sahnger says really burns me. He mentions that having a “lesser payment…gives the luxury of choice.” First of all - $64 measly dollars gives more choice? Okay… And second, since when has someone in debt had more choice than someone not in debt? When you are in debt you are obliged to pay, as the Bible says, you are “slave to the lender.” So who really has the luxury of choice in the long run? The person who choose to live debt-free. What does debt-free mean to me? Your house payment, on a 15-year fixed rate mortgage, is at most 25% of your take-home pay. Other than that, you shouldn’t owe anybody anything. And congratulations, you just found a house you can afford.

They will compete with interest-only mortgages. Those, too, were a niche product until home prices began zooming in parts of the country three or four years ago. Now interest-only loans occupy a big chunk of the mortgage market in high-price cities as buyers hunt desperately for ways to afford absurdly expensive houses.

And please, don’t get me started on interest-only mortgages! Alright, why are home prices zooming? Because sellers are willing to pay that price. Why are they willing to pay that price? Because their monthly payments are jimmied low enough using financial instruments such as interest-only mortgages or these 40 year fixed rate mortgages. So, buyers “hunt desperately for ways to afford absurdly expensive houses” (italics added).

That’s an interesting (and wrong) use of the word “afford”. The applicable definition of that words is as follows: “have the financial means to do something or buy something”. I’m sorry, but if you need to pay only interest for the first 3, 5, or 10 years of your mortgage, or if you have to stretch the payment to 40 years, you cannot afford the house you so desparely want. Think smaller, or continue renting until you have saved more money for a downpayment.

Being debt free will give you the “luxury of choice” you want so badly. Do not proceed to attach ankle weights to your legs before beginning a marathon, and please don’t take a 40 year mortgage to “afford” a house you can’t.

Let me warn you right from the get-go. You’re hearing this from a guy that is pretty darn close to totally anti-debt. Now that I’ve disclaimed my bias, let’s discuss briefly an early mortgage pay off. Should you do it? Maybe.

I discussed a lot of the issues with mortgages, interest, saving that interest, tax-deductible interest, etc. in a discussion on the 15 vs 30 year mortgage question and the tax advantage of owning your home.

We’ll just breeze over the issues once again here, then you’ll be armed with the information you need to answer that immortal question: Should I pay off my mortgage early?

Alright. Everyone needs a roof over their head. There’s a cost involved there, whether you own your home outright or are still trying to pay off the mortgage. You need shelter. That’s a fact of life.

It is relatively easy to get quite a bit of money from the bank and be pretty well leveraged with your mortgage. I mean, you can get a loan-to-value of 5% ($5,000 down on a $100,000 home) pretty easily these days. I would say an LTV below 10% is pretty highly leveraged. This can be very advantageous with a mortgage.

Mortgage rates are extremely low right now (May 2005). This is cheap money! That is another advantage to a mortgage.

Your interest is tax-deductible. This makes an already cheap interest rate even cheaper!

The disadvantages of a mortgage? The interest cost is huge. For a $120,000 home, you could easily be looking at $170,000 total interest on a 30-year mortgage! Another disadvantage is the fact that you lose that monthly cash flow. If your home were paid off you could put those monthly “payments” to good use in an investment. Also, there is a lot of peace of mind that comes from not owing anybody anything. And you wouldn’t.

Consider the following scenario before you decide if you should pay off your mortgage early. Let’s take Ron, who is just crazy about owning his own home. He has an emergency fund in place with 3-6 months’ expenses. So he just goes to town paying off his 30 year mortgage in 13 years by paying an extra $300 per month. The result? In 13 years his mortgage is paid off.

But what could he have done with that $300 over the last 13 years? Invested it in the S&P 500. What would it have grown to? Without calculating all of the numbers, we can be reasonably assured that it would have amounted to a lot more than the interest he saved when he decided to pay off his mortgage early (alright, alright, his investment would be worth just above $95,000 invested at 10% for 13 years).

The general rule is this: if you have to decide between the early mortgage pay off or investing that surplus cash into something else, you would financially choose the one with the highest return (your after-tax interest rate is your rate of return because every dollar you spend paying it down is a dollar you don’t have to pay interest on). So if you can invest that $300 at 10% in a tax-conservative (low turnover) S&P 500, or save 6% after-tax, you would always choose to invest the money.

Is that 10% guaranteed? Heavens no! But over the long-term you’d be hard pressed to make an argument otherwise. Is that 6% return guaranteed? Heavens yes! That must be included in your decision to pay off your mortgage early.

I think Dave Ramsey has a pretty good plan. You need to make sure your foundation is well-laid before you consider paying off your house early. And this is coming from a guy that is about as anti-debt as you can get. He counsels his listeners and fans to follow his baby steps 1-5 before paying off the house. Why? Because steps 1-5 include getting together an emergency fund, getting rid of all debt excep the house, investing 15% in retirement, contributing to college funds for kids and then finally paying off the house early.

What this amounts to is that if you are already sitting on 3-6 months’ expenses in cash (money market, savings account, i.e. liquid), you don’t have any debt except for your house, you’re contributing 15% towards retirement (taking advantage of those possible 10% returns from the stock market and the great tax benefits that come along with investing for retirement), you’re even planning on helping your kids out with college, and you still have excess cash left over to pay off your mortgage faster? Man - go for it!

Forget about the possible 10% return of the S&P - you’re already making a killing contributing consistently 15% of your income - make a guaranteed return of 6% on that excess cash. And when you’ve paid off the house, take that payment you were making and go on a cruise. When you get back from the cruise, start socking it away for retirement.

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:

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!

My objective in writing this article is to dispell a myth that should have been dispelled a long time ago when it comes to the tax advantages to owning a home. For purposes of my objective, a better title to this article should be “The Tax Advantages to Owing on Your Home” because you only get the tax advantages if you are in debt.

Really quickly, we’ll move through the tax advantages to owning (owing) a home. When you enter into a mortgage, as you probably know, a large portion of your monthly payment will go towards interest. As you pay down the principal, the interest portion of the monthly payment grows ever smaller, while the principal amount of your payment (the portion that goes towards actually paying down your debt) grows ever bigger. This interest is tax deductible if you choose to itemize your tax deductions. This tax advantage can be pretty lucrative for just about everyone - especially when you’ve first entered into the mortgage because you will naturally pay more interest.

However, it is a tax advantage. If you could choose to pay tax or pay taxes with an advantage, you’d choose the latter. That makes perfect sense. But never forget how this tax advantage actually becomes available.

You have to be paying interest.

Even savvy tax advisors will tell people the following: “Oh no, don’t pay your home off early. You’ll lose your tax deduction!” I feel sick to my stomach. Very well educated people tote this as a reason to stay in debt.

Would you like to guess who really pushes the tax advantages to owning (owing) a home? You got it–mortgage brokers, banks, loan officers, etc. They stand to profit from you stringing that mortgage out as long as you possibly can. They’re probably hoping you’ll take out an equity loan as soon as you get a chance too. There’s a conflict of interest if you’re taking advice from your lender when it comes to the tax advantages of owning a home.

The lender will give you, let’s say, a 7% interest rate. At the same moment he’ll tell you that the real rate or effective rate is only 5.6% if you’re in the 20% tax bracket, and 4.9% in the 30% tax bracket (you can get to these numbers with the following formula: interest rate * (1 - tax rate) ).

They never really mention that the tax advantage is only made available because you’re still paying them 5.6% or 4.9% on the loan.

Owning a home is a wonderful, wonderful thing. When I say owning I mean owning. You don’t make house payments. We’ll run two different scearios to drive home this point. Paying your house off early is and always will be better than having a tax deduction for the interest you pay.

We’ll use the following numbers:

• Sale Price: $150,000
• Down Payment: $30,000 (20%)
• Interest rate: 7%
• Tax rate: 25%
• Time: 30 years

By making only two extra payments per year you are out of debt 10 years faster and save $48,317.68! Remember, I’m including the tax “advantage” to owning a home in this calculation. Any way you cut the cake it’s still going to come out the same.

Finally, the tax advantage is there to promote home ownership, so I do appreciate it. It certainly does help. It is a nice benefit. But in no way does it outweight being entirely debt free with almost $50,000 saved as a result. Think about it this way–would you give me $1 to save $.25? Of course not. Yet that is exactly what you’re doing when you decide to not pay off your mortgage in favor of a tax advantage you will be giving up. That is a ludicrous idea. The numbers are here and they speak for themselves. Ownership will always be better than borrowing when it comes to funding your lifestyle securely.