15- vs. 30-Year Mortgage–Which is Best?

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Wow, I never thought of it this way. Why paying less interest on a 15- vs 30- year mortgage can be good OR bad.

Some of you may remember that my husband is taking a course in calculus. It’s going really well for him.

A few weeks ago, his class was working on amortization tables. They were given an assignment to find a house they’d like to buy then figure out the difference in interest if they took out a 15-year mortgage versus a 30-year mortgage.

He was sitting there doing his work when I heard, “What the heck?!”

“What’s wrong?”

“Why would anyone ever take out a thirty-year mortgage?”

Here’s what he was looking at:

 

We ran the numbers to see which was best---a 15- or 30-year mortgage.

Click to enlarge.

15-Year vs. 30-year Mortgage

That’s a $44,616.60 difference in the amount of interest you’d be paying over the term of your loan. The interest rate is the same for both loans: 3.8%. And the cost of the home is $158,500 after assuming the seller came down $5K. (Yay for the Pittsburgh housing market!) There is also an assumed down payment of 20%, or $31,700.

Literally the only thing that caused that $40K+ difference was the length of the loan.

Want to run your own numbers without having to do calculus? PenFed has a great tool to compare the two mortgage lengths; just enter your own parameters!

This led us into a pretty in-depth conversation about our housing situation. We’re currently saving for a home, but don’t yet have the 20% needed to avoid PMI. While we could totally afford a 15-year mortgage in the given price range, we also have pretty hefty property taxes in our county which may or may not take us outside our desired budget.

In his paper, he chose the 15-year mortgage. Because obviously. It’s way cheaper.

When a 30-year Mortgage is Smarter

Just because it’s cheaper doesn’t necessarily mean it’s a better decision, though. Our income is notably variable. Let’s say we could afford a 15-year mortgage at $933.79 per month and the additional $250-$400 per month in property taxes. And then home owners’ insurance on top of it.

What happens if we have a bad month? We could obviously draw cash out of savings. But what if we had a bad quarter? What if, like last fall, an income stream suddenly dried up? (This last one could happen to anyone, regardless of if they have a variable income or a “steady,” every other week paycheck.)

In that case, we’d be glad to have the longer mortgage with the lower monthly payments of $590.83. It would give us $342.96 of wiggle room per month, and, as long as there’s no pre-payment penalty, there would be nothing to stop us from paying off the mortgage early.

Which is exactly what we would do. Let’s say we made the same $933.79 monthly payment every month, but got the 30-year mortgage. We’d still save $39,222.71 in interest. And we would have given ourselves flexibility should we meet a lean month.

The Investment Argument

There’s an argument out there that says because interest rates are so low at the moment (3.8% in this example, and even lower for us with our preapproval,) that you stand to build more wealth in the same period of time by investing the difference between a 15-year and 30-year mortgage.

In our example, $342.96 invested monthly over 15 years adds up to $96,614.64 if we assume a 6% annual rate of return. We’d still owe roughly $81,635 on the house and have $76,865 in equity. If these were our only sources of net worth, our wealth would equal $91,884.64. If we had paid off the mortgage only via a 15-year mortgage, our net worth would all be tied up in our house, and it would equate to $158,500.

Not a strong argument, unless we used the investment to pay off the home. Then our home equity would be $158,500, plus the $15,664.64 leftover in investments. This calculation is generous in that it doesn’t include the tax bill we’d have to pay for pulling that money out of the market.

Investing the difference would make us more than $15,000 richer and give us more diversity in our investments. Investing the difference and using it to pay off the mortgage 15 years down the line would appear to be the clear, best answer.

But assuming a 6% return is dangerous on a short-term basis. (I consider 15 years a short-term timeframe given my age and risk tolerance.) Then there’s the fact that no matter how it’s classified on paper, we will not be viewing our home as an investment. For many, the mental burden of debt will win out even over solid numbers that show they will be building wealth. (We’re not of that ilk, but it’s another thing to take under consideration.)

What’s the best answer?

Should you get a 15-year mortgage to save on interest? Should you get a 30-year to give yourself some flexibility, combined with an early pay-off plan? Or should you get the 30-year and invest the rest?

So much of it is personal. It depends on your financial situation. It depends on your money philosophy.

We haven’t quite decided yet. Admittedly, we probably won’t go the investment route. While the husband picked the 15-year on his assignment, the flexibility of the 30-year mortgage with an early payoff date is an enticing option, too.

What would you do?

 

*This post is in partnership with PenFed Credit Union.*

 

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21 thoughts on “15- vs. 30-Year Mortgage–Which is Best?

  1. Tim

    You could do a 5/1 and lock in the current rate with the option to refi to the 15 in 4-5 years when you are in a more certain situation.

    Reply
  2. Amanda @ centsiblyrich

    I like this debate and have it with myself and my husband on a regular basis. There really is no clear answer on the best option. I think it’s important to stick with what you are comfortable with, while taking into consideration your age and situation. It’s great that you are thinking all of this through before you jump into a mortgage – that puts you ahead of most!

    We are taking a multifaceted approach. Our retirement goals include having enough in investments to pay off the mortgage, but we are also slowly starting whittle away at the principal now when we have extra money.

    Reply
  3. NZ Muse

    I obviously don’t know the intricacies of the differences between US and NZ but I don’t know anyone with a less than 30 year mortgage here. However many people have a portion of their mortgage balance floating (on a variable rate) and so can focus on paying that down as fast as possible or as finances allow (I’m doing that). I might write about this soon.

    Reply
  4. Done by Forty

    We took out a 15 and paid it off in like 3 years. It was colossally stupid. For those who can invest regularly, the 30 year mortgage is undeniably better, IMO. (And 30 years is a plenty long time frame for investing return averages to play out.) The interest rate is a tiny bit higher, but the avoidance of opportunity costs makes it more effective over the term of the loan.

    Now, the rub is actually investing the difference. But for us, our rentals and future primary home purchases (and, um, the cash out refi we’re doing on the paid off house) we’re going 30 year fixed and couldn’t be happier with it.

    And of course, if you just want to be debt free in a short amount of time like we did, throw all that out. Just realize that opportunity costs are real. I wish someone had told us that when we were paying off our 4.25% mortgage instead of investing that money from 2010 to 2013, and the market was going bonkers.

    Reply
    1. Femme Frugality

      True. I suppose I limited my perspective by limiting the investment period to just the first 15 years. And true about ACTUALLY investing it, too. You have to be really familiar with your own, personal behavioral finance habits to be sure you’ll follow through and make the whole thing truly advantageous.

      Reply
  5. Andrew@LivingRichCheaply

    We took out a 30 year mortgage since we wanted the flexibility…can pay more when we have excess cash but aren’t locked into a higher monthly payment. And living in the NYC area…housing is expensive it would be tough to have a higher monthly payment. Also, since interest rates are low, I do prefer the 30 year mortgage and investing the difference like Done by Forty said

    Reply
    1. Femme Frugality

      We’re so lucky with our prices here in Pittsburgh! We do have pretty high taxes, but I can only imagine trying to break in in NYC. And expanding the investment horizon to 30 years does change things!

      Reply
  6. kay ~ the barefoot minimalist

    Wow, this is WAY over my head, but I would choose the 30 year with the early payoff option. My parents bought their house in 1972 for $15,000. By the time they paid it off in 1983, the payoff was 13,000. How’s that for just throwing 11 years worth of monthly payments down the interest drain? The bank tried to convince them why it was so much smarter to just continue paying the mortgage rather than pay off the house. Fortunately, they hadn’t been born the day before. Best wishes on finding your dream home Femme! You’re definitely doing your homework. 🙂

    Reply
  7. Prudence Debtfree

    Like you, we have variable income, so what we have done is to set up a basic payment with the option of paying extra each month. If my husband’s business is good, we can as much as double up on the basic payment. If it’s not, we just make the basic payment. The danger of the 30-year option is the fact that it takes a lot of self-discipline to make those extra payments – especially for young people. But since you are dealing with variable income, you have that discipline. So I vote for the 30-year option – to accommodate the variable income – but with the plan to pay it off in 15. All the best!

    Reply
    1. Femme Frugality

      The discipline is so key, whether you do a 30 in 15 or take the 30 in favor of investing the difference. And you’re really right… A variable income does force you to have some seriously good planning mechanisms in place for your personal finances!

      Reply
      1. Prudence Debtfree

        If it’s a contest between extra money going towards early repayment or extra money going to investments, my vote would be to split it right down the middle. Psychologically, it’s more satisfying to go 100% one way or the other, but in long-term undertakings like this, I’d go 50-50 (another tough discipline thing!) with the idea of going 100% on investments once the mortgage is paid off. It might be my age and my horror of any kind of debt talking, but that’s my 2-cents : )

        Reply
  8. Rachyl

    My husband and I have had this discussion before, and we like the flexibility of the 30 year loan. We can pay extra on our mortgage whenever we want and still lower the amount of interest we will pay.

    At 3.8% interest, I don’t feel a 5/1 ARM is a good idea. You may end up having to lock your interest rate at a much higher percent in a few years. Also, you will never be truly secure in your income, as you can be laid off or lose an income stream.

    As always, a great post!

    Reply
  9. Kalie @ Pretend to Be Poor

    Great treatment of the topic. We were also torn on this. We started with a 30-year, and started paying it like a 15 year. Then we refinanced when rates dropped and went with a 15 year. Now we’re pre-paying that. But we bought what we could afford on one income (we are not in a high COL area) so we’ve always had enough flexibility even within that 15 year mortgage. The investing scenario is compelling mathematically, but emotionally, we’d rather have less debt. It’s definitely a complex question.

    Reply
  10. Taylor Lee @ Yuppie Millennial

    I chose a 30 year fixed since a 15 year fixed would have required more cashflow than I was willing to earmark for the house (in case, e.g. I lost my job) and since interest rates are set to go up I wasn’t thrilled about the idea of an ARM (though at their current progression rates may barely go up at all 5-10 years from now).

    Reply

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