However, I can tell you almost immediately that you’ll be paying less interest overall because you went from a 30 year to a 15 year loan. If you can afford the increased payment, it sounds like a smart move.

You *might* earn a higher yield in the markets by investing, rather than paying down your loan on shorter terms (15 yr).

However, 1. you will pay taxes on your market returns…

and

2. When you sell your house the profits (up to fed limits, 250k or 500k) are NOT taxed.

and…

3. you will be mortgage free in 15 vs 30yrs. Talk about “freeing up cash”.

Dumb…dumb…dumb?

Paying down a mortgage aggressively makes sense if you already have some significant investments in other markets that you would expect to earn a higher return (i.e. the stock market). If your home equity makes up about 20-30% or less of your net worth, then paying additional equity by having a shorter term mortgage makes sense. If your home equity is 50% or more of your net worth, then you might be better off with the lower payment and investing the additional capital in an S&P 500 index fund, a Russell 3000 index fund, and/or a broad-based international index fund.

In this way, you are building a balanced portfolio between home equity and market-based investments.

Waffler, I would think long and hard before I paid a bunch of money in refinancing fees to willingly take a 1% higher interest rate. A 15 year fixed at 4.375% is a great deal. Also, you said the net assets were about the same in 360 months. That assumes that you stay in the house for 30 more years. I suspect that if you only stay in the house for 10 or 15 more years, staying in the 15 year mortgage makes a lot more sense. And you may be fairly confident that you’re in the house for the long haul, but a lot can happen over that period of time. Good luck with your decision.

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.

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.

(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!

@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.