The 15- vs. 30-Year Mortgage Savings Myth
If you’ve ever lamented the fact that you signed a 30 year fixed mortgage instead of a 15 year fixed mortgage (it was one of 8 regrets of 2007 for Trent of The Simple Dollar) because of how much money you could’ve saved, don’t. I’m going to do some simple Dinkytown.net (using this fixed mortgage loan calculator) math to show that the difference between prepaying a 30 year fixed mortgage and a 15 year fixed mortgage is big. The current rates on Bankrate (as of early morning on April 16th, 2008) for a 30 year fixed mortgage is 5.62% and for a 15 year fixed mortgage is 5.20%, so we’ll be using those. Rates have since changed but the analysis still holds.
If you had a $300,000 mortgage and made additional payments (~$677) onto the 5.62% 30-year mortgage such that the payments matched the 5.20% 15-year mortgage (~$2403), the difference in total cost (principal and interest) is ~$19,153 pre-tax across fifteen years. After you discount it by your marginal tax rate (say 25%), divide it across the 180 months, it’s only $79.80 a month. $80 difference on a $2403 mortgage payment is 3.3%.
You might say: “Jim, you’re just conveniently ignoring the $19,153 and focusing on the smaller monthly number of $80 - that’s just mathematical hocus-pocus. I’m upset about the $19,153! Also, $80 might not be a lot to you Mr. Money-bags, but I’d rather have that money than give it to a mortgage company.”
To which I would respond: “Ah, good point, but let us calculate the present value of that $80 a month and see how much it’s really ‘worth’ to us today. As for the $80, I too would rather have it in my pocket, but I’m not going to cry over spilled milk.”
If you assume that inflation will be at 4% a year, 180 payments of $79.80 is worth approximately $10,788 today (if I did it right in my TI BA-II Plus calculator). It’s a $10,788 difference on a $300,000 mortgage. Ten thousands dollars isn’t a trivial amount of money, but that’s the cost of having the flexibility to make the 30 year payment into a 15 year payment if you want to. If you have a 15 year mortgage, you are required to make that payment.
Lastly, if you still are bothered about the difference, you can always refinance. 
(someone please check my math!)
16 responses to “The 15- vs. 30-Year Mortgage Savings Myth”
The Dough Roller responds:
Posted: April 18th, 2008 at 9:03 am
Blueprint, I’m with you on this one. I would trade the $80 a month for the flexibility a 30-year mortgage gives me in a NY minute. Of course, that assumes the spread between a 30 year and 15 year mortgage is about 50 basis points. If it goes higher, as it has with some jumbo loans, the 15 year mortgage starts to look very appealing.
jim says in reply:
Posted: April 18th, 2008 at 9:15 am
Excellent point, the larger the spread, the more of a premium you pay for the flexibility.
Llama Money responds:
Posted: April 18th, 2008 at 9:53 am
While I generally don’t advocate taking a longer term loan than you have to… I like your analysis. $80 per month is a reasonable amount to pay to have that flexibility. Tough times happen, even to the most prepared individuals. Having that flexibility is worth the small price.
Marc responds:
Posted: April 18th, 2008 at 10:43 am
Another factor, which you didn’t include in your analysis, is the investing of those flexible dollars from the 30-year loan. With today’s low rates (mine is 5% for a 30-year from about 5 years ago) over the long-haul (such as the life of the mortgage) you should be able to make significantly more than the interest rate investing it and not necessarily in risky investments. In fact, until the recent Fed cuts, my money market was over 5%. So when I bought my current house, I took out an 80% loan (max without PMI) and took it for the longest period I could since the rates were so low.
The above analysis (and yours) only works if you have the discipline to not blow the extra money on crap.
Miller responds:
Posted: April 18th, 2008 at 12:20 pm
I re-ran the numbers with a slightly different approach. First, dinkytown throws in ponits paid and closing costs, etc. All well and good, but I wanted to completely isolate the mortgage part of the payment. So, I just did a raw mortgage calculator (bankrate.com).
Instead of calculating the difference in the interest in the end and then averaging it out, I just took the difference in the required payments between a 15 year mortgage at 5.62% and 15 year mortgage at 5.2%. The 15 year at 5.62% would be exactly equal to the 30 year at 5.62% if you force yourself to make the extra payments to kill the mortgage in 15 years.
Anyway… the difference is $64/month — close enough to your $80/month. So, yea, we verified your math. =)
I guess with everyone else’s comments too. Basically, unless the rate spread is more significant (maybe 3/4 a point?) or you just aren’t well disciplined enough with your money, the longer loan is better. With that said, I bet we all think we’re a lot more disciplined with our money than we really are. =)
When it comes down to it, I think most people choose the 30 year simply because the payments are much cheaper ($675/month in our example), hence easier to afford that bigger house.
Brandon responds:
Posted: April 18th, 2008 at 1:33 pm
The value of your house won’t appreciate any faster based on your mortgage balance. If you want to get ahead, you need to keep the mortgage and invest the extra $677.
After 30 years of investing $677 a month at an estimated 10% annual rate, you’ll have over $1.5 MILLION “in the bank”!
I just don’t understand the drive to pay off a mortgage, especially a first mortgage.
Brandon responds:
Posted: April 18th, 2008 at 1:35 pm
BTW, that $1.5 MILLION does not count the equity in your home.
FHR responds:
Posted: April 19th, 2008 at 8:28 am
@Brandon……the drive is psychological. It does feel great not to owe anything to the “MAN”.
Funny about Money responds:
Posted: April 19th, 2008 at 9:48 pm
This is about what I’ve been thinking, but because i are a english major i are not a mathematician, I’ve never been able to figure out any calculation that confirms my suspicions.
Gut instinct tells me
a) having the option instead of the requirement of paying more toward the mortgage is safer;
b) inflation drops the relative cost of a mortgage payment over time, so that as time passes your ability to make extra payments should grow and so should your ability to put extra money in savings;
c) early in the mortgage when the yet-to-inflate cost feels high, you’re better off with smaller payments that let you invest extra money in other long-term financial instruments;
d) most people don’t stay in a house for 15 years, & so there’s no rush to pay off the loan;
e) given the current state of the real estate market, I’d rather build equity somewhere else just now; and
f) if you lose your job and end up in lower-paying work, which seems to be a pattern these days, you’re better off with a 30-year mortgage’s lower payment.
That said, my mortgage is paid off. Why pay off your mortgage? Gives you lots more money to live on; raises your standard of living commensurately; doesn’t make all that much difference in your taxes; and makes it possible for you to invest a great deal more in the stock market.
Ken Montville responds:
Posted: April 20th, 2008 at 2:43 pm
The math may be right but it doesn’t address the behavioral aspects of the 30 year mortgage. As Marc (above) mentions, The above analysis (and yours) only works if you have the discipline to not blow the extra money on crap.
That’s a big if. With marketing and advertising being what it is a 15 year mortgage may be the only discipline people can muster to get rid of debt sooner rather than later.
To Funny About Money — one should always be building equity in their home regardless of market conditions. No one can time the real estate market cycle any more effectively than they can time the stock market cycle. If we could, we’d all be multi-millionaires. I really don’t think we’ll see an accelerated boom like we did from 2000 - 2005 ever again but the cycle will come back and appreciation will occur and when that happens people who have slowly but surely been building equity by paying down their mortgage will be in a better position to enjoy the good times (assuming they want to move…which is not a given).
Kelli Myers responds:
Posted: April 22nd, 2008 at 2:33 am
I dont go for long term loans and for me even that $80 matters. Since I strongly believe in saving so if I save $80, even if its quite a small amount it would add to my savings.
NtJS responds:
Posted: April 22nd, 2008 at 10:42 pm
The problem with pre-paying a 30 like its a 15 is not the math. It’s the fact that most people with a 30 don’t pre-pay it. It’s the habits, not the math.
Good analysis, though.
Dave (ChiefExecutiveRockStar) responds:
Posted: April 23rd, 2008 at 8:54 pm
In considering value, one more factor (other than dollars and opportunity costs, as mentioned above) is where to place the risk. It’s not the greater the risk, the greater the reward (as any good broker will gladly advise you - hey, it’s not THEM taking your risks).
Banks like to reduce their risk by getting dollars returned sooner; plus this way they can loan out those dollars again. They offer incentives for such behavior (lower rates on a 15 year).
There are individuals who feel more comfortable allowing the bank/lender to hold the majority of risk for as long as possible - maybe even indefinately, thru refi’s or interest-only loans.
Learning to mitigate risk to zero or near zero is what banks move toward (banks, not bankers). We could learn from this.
–Dave Charbonneau, CER
Getting To Enough responds:
Posted: April 28th, 2008 at 8:01 am
I’ve been on the fence about whether my next mortgage will be a 15-year or a 30-year one, so I found this post to be especially relevant to me.
One aspect that I don’t necessarily agree with is the notion that $10,788 isn’t a lot of money in the context of a $300,000 mortgage. I think that $10,788 in today’s dollars IS a lot of money to someone who has a $300,000 mortgage. It shouldn’t matter that the $10,788 in savings is coming from a $300,000 mortgage. It’s the same as if you had saved it in any other way.
If you think about it, there’s very few ideas that someone could read on a blog that would save them more than $10,000.
I do agree that you have to look at your own situation and decide whether the flexibility is important enough to you. Especially important is the stability of your job in this economic environment. I think the post does a great job of spelling out the real costs of the example mortgages.
RalphF responds:
Posted: April 28th, 2008 at 8:16 pm
What is the group consensus on this issue if a) One plans to move in 5, 7, or 10 years and b) One is pretty confident of selling at a small gain (or at least, not at a loss).
As one who has never lived in any one place for particularly long, I find the discussion about “getting the house paid off” kind of irrelevant to me. I’m leaning towards a 30yr for the added flexibility and for the investment opportunity of the additional cash. The 15 yr kind of strikes me as the type of mortgage to take out if a) one is looking to instill self-discipline and b) one plans to go deep into the term of the mortgage. Is that a decent way to read this decision for one in my situation?
Thanks for this post and for the discussion. Very helpful and great timing given I plan to refinance a 7/1ARM into a fixed this summer.
Industry and Frugality responds:
Posted: May 4th, 2008 at 12:33 pm
This is a really great post. I never realized how big the difference between the 15 and 30 year mortgages really was.