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The 15- vs. 30-Year Mortgage Savings Myth

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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, but you can also use Bankrate’s mortgage calculator) math to show that the difference between prepaying a 30 year fixed mortgage and a 15 year fixed mortgage is not 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. :)

{ 37 comments, please add your thoughts now! }

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37 Responses to “The 15- vs. 30-Year Mortgage Savings Myth”

  1. 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.

  2. jim says:

    Excellent point, the larger the spread, the more of a premium you pay for the flexibility.

  3. Llama Money says:

    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.

  4. Marc says:

    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.

  5. Miller says:

    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.

  6. Brandon says:

    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.

    • DD says:

      That’s only if the market doesn’t crash!

    • cdiver says:

      For most people, it is the easiest way to get a guaranteed return.

    • SSSharpie says:

      I just don’t understand the drive to pay off a mortgage, especially a first mortgage.

      Brandon, I hope you didn’t lose your shorts since you posted this comment.

    • Tim says:

      Sorry – where’s the 10% guaranteed APR coming from? And the reason it needs to be guaranteed is because the 15 year flat mortgage rate is just that.

      I just ran my numbers, trying to figure out if what you’re saying is right.

      My current total interest on my 30 year at 5% is 164k. I’ve already paid 17k over the last two years, so that leaves about 147k interest left to pay.

      My increase out of pocket per month for a 15 year loan is $300.

      Using this (http://www.patrickschneider.com/compound_interest_calculator.php) calculator, plugging in $0 starting, $300 per month, and a more ‘realistic’ 5% APR (although you’ll have to educate me as to where I could get that these days), I end up with $250k after 30 years, but I’ve paid $164k in interest. Net 86k.

      Now, let’s say I refinance and pay off my loan in 15 years @ 3.7 APR. This reduces my remaining interest from 147k to 50k. (Total interest over life of loan = 67k.)

      Then, for the next 15 years, I take the $900 I would have paid as mortgage and invest @ 5%. This results in 240k after 15 years. 240k – 67k = Net 173k.

      A fifty percent better net in half the time results in a much better return.

  7. Brandon says:

    BTW, that $1.5 MILLION does not count the equity in your home.

  8. FHR says:

    @Brandon……the drive is psychological. It does feel great not to owe anything to the “MAN”.

  9. 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.

  10. 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).

  11. Kelli Myers says:

    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.

  12. NtJS says:

    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.

  13. 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

  14. 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.

  15. RalphF says:

    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.

  16. This is a really great post. I never realized how big the difference between the 15 and 30 year mortgages really was.

  17. Anonymous says:

    I’m confused. A $300K mortgage for 30 years at a rate of 5.62 amounts to a bit more than $621K by the time it’s paid off. A $300K mortgage for 15 years at a rate of 5.20 amounts to a bit less than $433K by the time it’s paid off. I can see that had the 30 year fixed mortgage been at a lower rate I would have saved a rather small amount of money maybe, but in the end going with a 15 year fixed still saved me $188K at the end of the day (well, at the end of 15 years, really) not $19K. What am I missing?

    • Chuck says:

      You are mixing the term with the rate, which makes it confusing. You could compare the 5.62% mortgage with the 5.2% mortgage on the same term of 15 years. Obviously at the same term, the 5.2% mortgage is better. But you don’t have the option of paying 5.2% for 30 years. The extra cost is the cost of freedom to stretch out the payments if you want to.

      The 30 year term will always result in more interest, because you’re carrying the balance for twice as long! But the value comes in what you can do with the money instead of paying it to the bank. If you can’t do anything worthwhile with it (anything better than getting 5.62% on it, for example) then by all means, get the 15-year loan and save the extra $19K.

  18. 1530 says:

    I’m doing a 15 year refinance from a 30 year fixed. I just don’t have the discipline to add the additional funds. I’ve tried, sometimes I can make the $200 or $500 added payment to principal but not every month, now the rates are significantly lower than my current 30yr at the 15yr fixed of today. A few years ago we refinanced a previous home with a 15 from a 30, threw extra money at that loan and rent that house out with the payoff in 3 years. So our $250 rental profit will become $1400 in 3 years. My first house was a 30yr and I wished the $1675 income I now make had started 15 years earlier. I know your numbers are right but my head wasn’t. I needed that monthly obligation. In Europe I don’t think they have 30 year notes. A cousin there worked two jobs for 6 years to pay off her 7 yr. note on a 85,000 Condo. Now the rental she receives allows her to live in a larger apt she is buying. 1530

  19. kevin says:

    Not one person on this planet has the discipline to pay off a 30 year in 15 years. I’m sticking with my 15 year. 9.5 years left!

    • JDog says:

      Who are you to say that not one person on this planet has the discipline to pay off a 30 year in half the time? I personally know of people paying off 30 year mortgages in under 10 years. Where is your logic now?

      • DD says:

        I agree! If I keep my current payment at $137 extra on each monthly payment (that’s AFTER principal, interest, PMI, ins. & taxes), I will drop 13 yrs. off of my mortgage!

  20. Brad says:

    Your post makes no sense if I’m reading your math right.. The average inflation rate since 1950 is 3.84, and since 1990 is 2.95.. not sure where you are getting your 4% figure..

    180 payments of $79.80 is $14,364, not the $10,788 you claim your calculator told you.

    AND you can only refinance if rates go lower, otherwise you lose money.

    Am I missing something, or possible doing the numbers totally wrong?

  21. Brandon says:

    Check your math again, buddy.

    Reality is the 15 pays $132,676 in interest vs 30 pays $220,289 over 180 payments. That’s a delta of $486 a month in savings.

    http://calculators.aol.com/tools/aol/home06/tool.fcs?param=sGx*tHp5pnsNrWp0pmpxtmBEtGlyt211tA@@

    • Mr. G says:

      The math is correct. You are failing to include the $677/mo. additional payment on the 30 yr. mortgage so it is paid off in 15 years.

  22. shelly says:

    Is paying by-weekly the same amount of intrest paid to the bank as one extra payment yrly ? Or do I pay more interest on one of them by the end of a 15 yr term ?

  23. Suzi says:

    Wouldn’t it be smarter to pay off your home in 15 years instead of 30 years if you can. I’ve looked into this and it isn’t much more per month to refinance a 15 year loan than the monthly cost for a 30 year loan.

    • cdiver says:

      Absolutely, as long as you can afford the extra cost and are not confident in your abilities to get a higher return elsewhere.

  24. Patrick says:

    The main reason a 15 year is better is:

    A 15 year mortgage always pays off in 15 years no matter what(given you make the payments.

    A 30 year paid like a 15 rarely pays in 15, once humans are factored in the equation.

  25. Jim,

    The difference between a 15 year and 30 year on 300K loan (assuming 20% down) isn’t 20k… check your math. Its 150K (278K in interest versus 124K in interest)

    I don’t understand how letting the bank compound 6% against you for an extra 15 years raising an addition 150,000 in interest isn’t that big of a deal. The average American probably isn’t savvy enough at investing to beat 6% a year on their money, so they are better off paying down their mortgage instead.


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