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15 Year Mortgages Are 30 Year Mortgage With Extra Payments!
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A reader once asked: What’s the difference between getting a 15 year fixed mortgage and getting a 30 year fixed mortgage and then paying extra onto the principal?
My answer is: nothing. Let’s do the math…
The two loans are:
- 15 year fixed loan for $300,000 at 5.0%, vs,
- 30 year fixed loan for $300,000 at 5.0%.
Here’s how the stats compare (based on Dinkytown calculators):
Loan Terms | Monthly Payment | Total Interest | Total Paid |
15 Year Fixed | $2,372.38 | $127,028.69 | $427,028.69 |
30 Year Fixed | $1,610.46 | $279,769.69 | $579,769.69 |
Difference | $761.92 | -$152,741.00 | -$152,741.00 |
The above table should come as no surprise. The 30 year fixed mortgage has lower payments because it’s over 30 years but comes with the additional cost because of interest. Now, what if you were to take the difference in the monthly payment, $761.92, and apply it to each additional payment on the 30 year fixed mortgage? You would get the following:
Loan Terms | Monthly Payment | Total Interest | Total Paid |
15 Year Fixed | $2,372.38 | $127,028.69 | $427,028.69 |
30 Year Fixed+ | $2,372.38 | $127,028.69 | $427,028.69 |
Difference | $0 | $0 | $0 |
That’s right, there’s no difference whatsoever (this makes sense though!).
{ 38 comments, please add your thoughts now! }
Jim-
I’ve never seen a bank offer a 15 for the same rate as their 30. Typically the rate is lower. A quick check of bankrate will confirm this.
Yea, the difference would be a higher interest rate and higher total interest even with the extra payments as a result.
This is why I advocate getting the lowest rate you can on the longest amortization available. Here’s also the big difference. If you are using the 30 year payment plan and lose a job your emergency fund will last that much longer when you only have to pay 1,610.46 vs 2,372.38.
You will never know the true cost and amortization until you make your last payment. As long as you are responsible (this is the key) the longer one will work out best in my opinion. With the way mortgages are fairly open these days with pre-payment options and payment flexability in increasing or decreasing as needed, who cares about how long the original amortization period is anyway?
Who wrote this post?
Like already mentioned above…there is one MAJOR difference, the interest rate is “always” lower on a 15-year fixed rate loan verses the 30-year. That is why there is a market for 15-year loans. No point in having that product if all you have to do is get the 30-year loan and pay extra on the principle and come out the same in the end.
Come on! If you’re going to give advice and do the math, at least plug in the real numbers.
I agree with the other readers, shorter loans normally have lower rates. Longer loans have lower required payments and so offer more flexibility with cash flow. If the rates and fees were ever the same I would go with the longer loan just to have that flexibility.
Yes, I understand that 15 year rates are always lower than 30 year rates, I was answering a reader question as to whether there would be a difference between the two scenarios.
These are also nominal values, I never took into account the effect of inflation (how a dollar in the 30th year is not quite the same as a dollar in the 1st year). This was a very simple comparison based on a question asked by someone who wanted to know the difference in this very specific instance.
15 year loans are dumb. Unless you have an abserdly high interest rate, you can do better by investing that money. Dumb Dumb Dumb…
Emily: Please tell me where I can invest given the current market conditions?
Tom, I answer your math question with a non-numeric economic answer: It’s pointless to go through the math exercise assuming a quarter-point reduction in rates on a 15-year loan. This is because the discount on rates for 15-years are set by the market such that the value of a 15-year at rate X is exactly equal to the value of a 30-year at rate Y. Otherwise there’d be an arbitrage opportunity where one can lend a 15-year and borrow a 30-year (or vice versa) and make a tidy profit.
In the mathematical representation of a mortgage comparison, the difference in rates would be an output, not an input.
Okay, so let me throw this out to all the math wizards out there:
Assuming a 15 year loan would have a quarter point reduction in rate, how much extra would you have to pay on a 30 year mortgage to end up at the same end point as the 15 year loan? For simplicity sake, use the numbers above as the basis of calculation.
The difference is that a 15 year mortgage will be paid off in 15 YEARS — guaranteed
No guarantee that you will pay off a 30 yr in 15 years!!!!!!!
I’ve got to refinance before the end of the year and I’m going with a 15 yr fixed instead of a 30 yr fixed because I’ll get at least a half point less on my interest rate. That’s why a 15 yr is better than a 30. However if you already have a 30 you might do the math – refinancing into a 15 yr may not be as good an option once you calculate refi fees. Just pay the extra payments and pay it off in 15 instead of 30.
I’ve always seen the 15-year rate at a cheaper rate than the 30-year rate.
I know you directed the question to Emily, but you can’t look at the market conditions now. You have to look at the market conditions over the next 15-30 years – the whole term of the loan. If you don’t like how the market generally performs over a 15-year span, I suggest some stable value funds for your 401k
The 15-year is certainly cheaper than the 30-year. This week I had a choice between locking in the 15-year at 4.625% or a 30-year at 5.25%. I chose the the 15 year and the lower rate.
One of the key factors in making this decision is how long you intend to own the home. If you are going to own your home for a long time (say 15 years), you are actually better off taking a 30 year mortgage with the lower payment, and investing the difference in something with a higher expected rate of return (e.g. S&P 500 index fund). However, if you are only going to own the home for a shorter period (5 years) then you are better off taking the shorter term loan, because it has the lower interest rate and you will benefit early on when the loan balance is high.
Of course my mortgage broker had it exactly backward. He advised me to take the 15 year if I might have the home for a long time, and the 30 year if I was going to get out quickly. Bankrate has a nice calculator for helping you select which one, although they ignore the length of time factor.
Of course, this all pre-supposes that you are able to make the higher payment on the 15 year without any problem.
Again, I took the 15 year fixed because I only expect to own the home for about 4-5 years. And in that short time period, the benefits of the lower interest rate are high, and if I instead took the lower payment and invested it in the market, it would need have an average annual return of over 13% to make up for the higher interest payment.
And thanks Emily, but I don’t consider it to be a decision that is dumb, dumb, dumb.
Kyle: Awesome reasoning – totally make sense. I went with a 15 year fixed with an interest rate of 3.25%. I had a 4.625% 30 year to begin with. Moving to 15 year was really a safe bet for me even if I really am not “planning” to sell my home after 4-5 years. But who knows what life brings? But, I now know with more sureity that I will be done with the mortgage commitment in 15 years and will be in a much better shape to help my son pay his college. If I had the “choice” of paying the extra amount into a 30 year, I would never do it as I always have 10 other things that I want to spend on! So, it really depends on your goals, your lifestyle and how you really manage your finances. I know that it is the right choice for me. No matter which one you choose, please make every effort to have atleast 6 months emergency funds stacked up – no excuses on that please.
Kyle, I don’t follow your thinking on this topic. Weather it’s a 30 year or a 15 year loan, your first several years will be mostly interest payments to the bank. Even though this is tax deductible, this is still money you are throwing out the window. If you plan on only having the home for 4 to 5 years, with the 15 year loan, you are throwing more money out the window than if you had the 30 year loan. Having a 15 year loan only helps if you plan on staying in the home long term, not short term.
Hopefully this isn’t too controversial, but interest payments are not “money out the window.” Interest payments are the fees you give lenders for giving you money upfront; you’re paying them for lending to you rather than putting the money to greener pastures.
If I have $100,000, I can put it into investments (including a savings account) to earn returns. If I instead give $100,000 to you as a loan, I expect to get something out of it to compensate me for the returns I’m losing. It isn’t good enough that you’re paying me back in 30 years, because $100,000 30 years from now is worth a lot less than $100,000 now. This isn’t just due to inflation but also due to risk and uncertainty.
I mean, I guess you’re right in the sense that interest isn’t equity. But the alternative is to spend 30 years saving up for a house, renting in the meantime, then buying one when you’re 50.
Get the longest term possible, period The difference between a 15 year loan and a 30 year loan is small that you should be able to use the same money to invest/save.
It always makes sense to have available cash in your hands because you can take care of emergencies and anything else that may come up.
Geez, some of you readers are rough on Jim! Just because some people understand “the game,” doesn’t mean everyone does! And if educating isn’t one of the main reason for blogging, then I’m stumped!
But I agree with what everyone said. 15 years *should* be lower interest rates, hence the motivation to get you to pay it back sooner. But this isn’t always true!
For example, my car loan 4 years ago. I could have gotten a 36 or 60 month loan, both for the *same rate*. After making sure there was no pre-payment penalty (make sure to check!), I chose the 60 month for the exact reason Jim is highlighting here (and most commenters realized also). I can always pay the higher amount myself and make my 60 month the equivalent to the 36 month. All I’m doing is giving myself flexibility to not *have* to make the larger payment.
Jim, while some people gave you a hard time for this one, I applaud it. As is proven by the reader who originally asked the question, this fact is important and not necessarily fully appreciated by everyone.
I agree with Lily that paying interest is not “throwing money out the window.” It is compensation for getting to live in a house that you cannot afford to buy outright.
Secondly, there is a significant difference in the amount of equity you will have with a 15 year mortgage and 30 year mortgage, even after 3 years. On a 200,000 mortgage, with a 15 year fixed (at 4.875%) your balance owed will be $256,130, whereas with a 30 year fixed (at 5.5%) your balance will be $287,180, a difference of $31,050. Now your payments will be about $650 higher per month with the 15 year fixed. But even if you set that $650 aside each month and invested it at 8%, you’d only have about $26,300 in the investment account. So you would have about $5,000 more equity by choosing the 15 year fixed.
Of course if you choose the lower payment, you’ll have more flexibility in what you do with the extra money, but you’ll also have more risk in trying to earn high returns in the stock market.
I agree that if you are worried about emergency savings, then you are probably better off to go with the 30 year fixed and put the rest of the money somewhere more liquid. Of course, if you pay down your balance more aggressively, it is probably easier to get a home equity loan or line of credit if something does come up.
Finally, the 30 year fixed is better if you are going to be in your house for a longer period, because the investment account that is set aside can earn a higher rate of return. But this assumes that you actually put it aside instead of blowing it on vacation or a BMW.
@Lily – You are wrong about the market discounting the rates for 15 year and 30 year mortgage products to be equivalent. There absolutely is an arbitrage situation where you can borrow short and lend long. What differentiates the products is RISK. A lender faces a much greater default risk on a longer term loan and inflationary risk is also much greater. If you can stomach the risk there is money to be made borrowing for a 15 year term and lending for a 30 year term, however the market has indeed made the margins very thin.
@Kyle – You’ve got it figured out about 15 year for short ownership periods and 30 year for long ownership periods. If you are going to hold a house for the long term you are able to invest the difference in payments in stocks and tolerate more volatility because you have a long time horizon. You also can maximize your tax benefits by deducting a A LOT of interest. On the other hand, if you are rapidly paying down principle and minimizing interest costs this is the best strategy for a short time horizon. You do not have long enough to invest in stocks and have a guarantee you will beat the interest on your loan. Rapidly paying principle will have less tax consequences as well when you have a short time horizon.
To complicate matters further you could add to the mix things like paying points, ARMs, option ARMs, and balloon payment loans. If you are a disciplined and have good credit there are several great options. There is inherently nothing wrong with these more complex products but they should only be used for consumers who understand them fully and have the means to utilize them correctly.
If I were to refi today I would use a 15 year fixed because my #1 priority is to build equity and minimize interest costs (I plan to stay 6-7 years in my current home). My next home I plan to live in for about 8-10 years so I probably will select a 10 year balloon payment. After that I will probably be buying for the very long term 30+ years so I will likely use a 30 year fixed.
Adfecto – 2-part answer to your great response.
(1) I never said risk isn’t the differentiating factor between rates. In fact, it’s the main differentiating factor: default risk, interest rate risk, liquidity risk. These are all built into mortgage rates to compensate lenders for the risks they assume. I don’t see how anything I said contradicts this.
(2) I agree that there is arbitrage opportunity. My response to Tom’s mathematical question is the the theoretical economic answer. However, even though in theory there are no arbitrage opportunities, the theory is based on the assumption that markets are perfectly efficient and everyone knows everything. This, of course, is not the case in the real world.
Jim – This thread is too fun!
If you have a huge amount of money (not me) then the 30-year-fixed may be a better deal if you’re planning to keep the loan for a long time. The fixed payment in today’s dollars will be a whole lot less in the future. Someone who offers 5.5% or 6% fixed for 30 years to a person who will keep it that long is a bit of a sucker.
So you’re saying everyone who buys a Treasury bill is a sucker?
This was a fun read. Shockingly enough depsite having advanced education in finance and accounting, I continue to waffle.. Save interest on the 15 yr/decrease cash flow or increase cash flow / pay out more in interest. I’ve been in my 15 yr @4.375% for almost 5 years now. I’ve been toying with the idea of refinancing to a 30 year @ 5.375%ish as this will reduce our payment by about 33%. I’ve run the numbers and shockingly enough we’re at a point where the net asset value in 360 months is about equal. I assumed 8% * 33% tax rate.
I’d love to have that lower payment, but there’s also something comforting knowing that it’ll be paid off in about 10 more years. I’ll be 45 at that time and my oldest will be starting to drive, so I’m sure there will be other bills that will need this money.
a couple of other items:
I also got hit with the AMT last year for the first time ever, so even additional interest might not be fully deductible going forward. My tax assumption is probably aggressive, as Mutual funds could be more tax efficient. I suppose I should probably build some what if’s and see what happens as the tax rate changes.