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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 (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. John says:

    The argument presented here is that if you think you can afford a 15 year loan, you can protect yourself against unforeseen circumstances by taking the 30 yr and making payments as though you took the 15 yr.

    Another approach is to compare the net investment. The net value is amount borrowed minus principal outstanding. The net cost is the total amount paid to date. The net investment is the net value minus the net cost. Calculate net investment for 15 and 30 yr, and then subtract the two for net benefit of 15 yr vs 30.

    To be consistent with the protect yourself against unforeseen circumstances, the 15 year calculation can be done with the 30 year rate.

    In any case, the result is that the shorter term at the same interest rate costs less, and a shorter term at a lower rate reduces cost more. Since the goal is to reduce cost, I would select the shortest affordable term. To fully evaluate the ability to make the higher payments, one could have a period of time where they make the higher payment in their current situation.

    • Tim says:

      AGREED! I really, really hope people Googling and hitting this post read down the responses.
      Who runs this site, and how/why is Jim’s post still a webpage on it?

      If you can afford the 15 year term and are early into your mortgage, you will save tens of thousands in interest.

      Also, with my modest mortgage (originally $173k 2 years ago):

      I would have to pay a whopping 75% more on top of my current monthly payment to equal the same interest savings by refinancing down 1.3 points to a 15 year loan with a 25% increase in my month payment.

      Going with the 15 year now will reduce my remaining interest from 118k to 50k, a 70k savings “return” on the 54k extra payments over 15 years. That return is bsically 3.5% APR based on a monthly contribution of $300 (the increase in my payment)

      Not to mention I will own my house outright in 15 years instead of 28.

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