What a difference a year makes. In August 2011, I did a mortgage comparison of a 15-year at 3.75% vs. 30-year at 4.75%. Now I’m redoing that same comparison at current market rates of 30 yr @ 3.25% vs. 15 yr @ 2.625%! To be fair, the numbers I used in 2011 were somewhat high.
In any case, the purpose of this comparison to compare the numbers if you wanted to pay down a 30-year mortgage in a 15-year accelerated timeframe, as opposed to just going with the lower interest rate and mandatory higher payment. I’ll be using the mortgage calculators at Dinkytown.
The 30-year at 3.25% would have a monthly payment of $1,305, while the 15-year would have a monthly payment of $2,018. Now, what would happen if we simply paid the $2,018 towards the 30-year mortgage? Using the calculator, we would enter an additional monthly payment of $713. That tells us the 30-year-plus-extra mortgage would be paid off in 15 years and 11 months, requiring 11 additional payments of roughly $2,000 and thus an extra $22,000 of interest in the end. However, the 30-year does allow me the flexibility to reduce my payment by about $700 a month if things get tight. Is the higher cost worth the extra flexibility?
I thought so when I got my first mortgage, but changed my mind once I figured that if I were to hit so hard that I couldn’t make the 15-year mortgage, I probably wouldn’t want to keep paying the 30-year either and would just sell the house and move somewhere cheaper and smaller. I viewed the potential payoff of going with the 15-year mortgage as being to retire one full year earlier.
Lots of people see the low interest rate for the 30-year mortgage and want to use that money to invest in the stock market. That may work out well if you actually invest your money as planned, I don’t know. I personally have enough invested in the stock market as it is, I don’t really want the extra leverage of essentially investing on margin with borrowed money. There is also a chance that the mortgage interest deduction may get capped or phased out over the next several years. That’s a lot of unknowns. I do know a top rate for a long-term certificate of deposit is the 10-year CD from Discover Bank with a yield of 1.90% APY. Meanwhile, the yield on a 30-year Treasury is 2.79%.
In the end, I don’t think there necessarily is a right or wrong answer. There are even more small nuances that went into my decision process, I’ll try and gather those thoughts for next week.
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The rates in bold in the first paragraph were transposed to the other mortgage lengths. That being said, is there any reason why you wouldn’t want a longer term mortgage that had a lower rate?
This seems like a trade-off between required cash flow and fast pay-off. If folks are more comfortable paying it off fast but knowing that they could go down to $1300/mo if something were to happen, they may go the 30 yr route. If having it paid down with the very least amount of interest paid is the priority, then it’s the 15 year route.
Hey, Jonathan,
I am your loyal follower, your blog is my daily bread.
In order to obtain your demonstrated rate of 2.65% (15 yr), don’t you have to pay a significant amount of closing cost? In Florida, that would rack up GT $5,000.
Can you make a comparison of NO COST refi at 3% vs your 2.65%? I am also thinking a 10-yr mortgage since it appears that the rate is no difference from the 15-yr loan. can you also chart it out to show 10-yr vs 15-yr, total interest payment if no additional payment is added.
thank you so much for your advise.
@Aaron – Thanks, fixed. If I could get a longer mortgage with a lower interest rate and no prepayment penalty (and same closing costs), then I’d get that and simply pay it down faster.
@Jo – I just grabbed the rates from PenFed (membership required, but free/cheap to join) with their zero points option, but with closing costs. The rate on a no-cost refi will vary depending on your loan balance.
It’s pretty easy to use the Dinkytown calculator to find the mortgage payoff time for your situation, but I’m not sure exactly which combo of term length, interest rate, and payment acceleration you are trying to compare?
Consider a 20 year as well as it is now becoming a lot more common in this rate environment, the rates are closer to the 15 year then the 30 year so you get both the benefit of lower overall interest plus better cashflow and shave years off of your total loan.
I refi’d into a 20 year (locked in 3.375% in August) for $417k, I continued making my previous mortgage payment and prepaid it town by about $13k to get my CLTV down to 80% with a $200k HELOC, I currently have just over 18 years left on the mortgage, I am considering doing a 15 year at 2.5% on my current $388k balance, my payment would go up by about $30 and I would shave another 3 years off the loan.
For those of you in 15 year mortgages 10 years have become quite popular too, so you can look to them for further reductions, the rates are about the same as the 15 year, so the payments go up, but it you have a 3%+ rate on a 20 or 15 year with more then 10 years left, this could be another oppurtunity to save.
Excellent post as this is something everyone with a house has to deal with. I chose the 30 year route not only because of the option to pay a lesser amount, but because it is phenomenal access to cheap money to do other things.
Cash is King! Where can you get a loan for anything at 3.25% which is tax deductible? If I want to start a biz and take off work, have a short term emergency or want to invest in the stock market I can do that.
If you lose your job, the ability to lower your monthly payments could buy you an extra month or two to look for work.
Also, one could imply that you aren’t following your own advice. As any money you have in the stock market (not in an IRA) is money you could be using to pay down your mortgage…
In other words, ANY money you have in the stock market is actually there because you are investing it using borrowed money.
You are just making the argument that you think you can beat a 2.65% rate over the long term investing on your own, but not a 3.25% rate.
As you say, it’s not a clear black and white choice, but more choosing where you want to be on a continuum of comfort.
Consider a 20 year mortgage the rates tend to be closer to the 15 year then the 30 year and they shortern the loan term, you get the best of both worlds. Also there are 10 year loans for those people already in a 20 or 15 year loan who want to look for additional rate and term reduction.
I also chose the 30-year. I’m currently only earning a little better than 1% on my savings and I’m not interested in putting any more money in the stock market. I do, however, think that at some point in the next 30 years that rates will be significantly higher than they are currently. Given that assumption, I’m socking away the difference in my savings account. If rates do rise above my mortgage rate, it’s possible that I come out positive. One could work out different scenarios on when rates rise and by how much to determine a breakeven point.
However even if that doesn’t happen, I prefer the additional flexibility and security that the extra money in savings buys me – especially in the current economic environment.
The numbers don’t lie – $22K + is a LOT of money to forgo for the “what ifs”. Flexibility is nice but is it worth $22K? I don’t know. Maybe if the person taking the mortgage had an iffy job.
I think I would (if I had the income requirements) do the 15 year and just build up an emergency fund for the just-in-cases.
There is certainly a lot to be said about having the additional flexibility, especially in this economic climate. Good luck trying to get refinancing if you lose your job, or have some other unexpected emergency. One needs to look at the financial costs translated into potential stress of worrying about what have become all too likely issues, even for the most responsible folks.
I have rental property and 15 year mortgages over time and many circumstances was tougher than I thought. Rents didn’t rise as anticipated, margins stayed thin and with the rise in property taxes and insurance and maintenance costs–30 year was simply the better choice. The 15 year paydown allowed for a refi 80/20 LTV when appraisals tanked so that was good.
You must take into account having adequate equity built up to be able to refi a home or investment property.
Front loaded interest by banks is simply awful. Half way through a 30 year mortgage you’ve paid the bank all of their money. The other years are simply principal. If they didn’t grab theirs first, equity would be built up faster and American home owners wouldn’t be in the mess they’re in today.
Jo, if you are looking at 2.65% @ 15yr, its -0.25 point (so the lender pays you 0.25% to cover your closing cost). If you go with 3% @ 15 yr, its -1.5 points. So depends on your loan amount, you can pick the lowest rate that covers your closing cost. Go to ProvidentFunding.com to see the points.
What a lot of people do is take the lowest with no closing cost (highest negative points), then just repeat every 6 months as the rate drops. So they keep lowering the rate at no cost. I have done this many times and its totally legit.
However I choose the 30 yr option because rates have been the lowest ever. People have been waiting 70 years for this rate. Even at 3.25%, its barely at inflation level. So its almost like a free loan. Then I dump the money I saved into another rental and keep the process going.
I am leaning toward the 15-year option myself. While the monthly payment is higher, you save money in the long run and achieve financial freedom a lot sooner. It would be great to have the house paid off.
What you fail to mention, and Tushar does not get, is that the $22k difference is in 15 years.
You are not talking about today’s dollars. These are dollars that you will have to shell out in 15 years… Now, if you account for inflation, opportunity cost, and maybe some risk, then the $22k will be a lot less. How much? Well it all depends on what your opportunity cost is, but if the “bank” is willing to make the tradeoff then it probably tells me that it is something of a wash.
Interesting analysis. How will choosing a 30 month mortgage paying the extra as a $9k – $10k lump payment at the end of the year play out in comparison?
You raise a lot of valid points in this piece, and I’m going to have to agree with some of the posters here. With today’s insecure job market, you want to be able to pay off your mortgage in the shortest amount of time possible. Investing can come in the form of government bonds or a tax-free savings account that has a high rate of return. I wouldn’t see myself being able to hack a 30-year mortgage; too painful, in my opinion.