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Choosing between a 15 or 30 year mortgage

With mortgage rates at or near all time lows again, it’s time to consider the ongoing question, do you choose a 15 or 30 year term? The 15 can be the way to go, especially if you are in your late 30’s or older and have a goal of having no mortgage at retirement. More than that, you’ll get a rate about a half percent lower which can save you some money as I show in this example:

mortgage

As you can see, the payment required to cut the term of your mortgage in half jumps by just over 40%, all of this extra money going to principal. Another approach you can consider is to take the 30 year term, at the slightly higher rate, and make payments for a 15 year payoff. You need to look closely at your finances and your own risk tolerance to make this decision:

  • Is there room in your budget for the higher payment?
  • Do you have any credit card debt you carry month to month?
  • Are you paying any other installment debt (car, boat, etc.)?
  • Are you depositing to your 401(k) at least to capture the full match, if available?
  • Do you have 6 months or more of emergency money set aside?
  • Are you and your spouse secure in your jobs (as if such a thing is possible these days)?
  • Are you expecting a child in the next few years and will lose some income during that time?

For many who are just moving into a house, it’s a better choice to take the thirty year, beef up your financial position, and then begin accelerating your payments. This isn’t rocket science, no complex math, just make extra payment each month to principal, and make sure the back is crediting it that way. For those who are paid bi-weekly, when you see that third check in a month (this occurs twice a year) you may use that money to pay down the mortgage. Another approach, if your retirement savings is on track, is to take half your raise and use that as your pay down money. The idea of having no mortgage is very appealing, but there’s one risk to consider. So long as you have a payment to make, that expense is still there. If I lost my job before the mortgage is paid in full I’d still prefer to have a well funded emergency account vs a mortgage that’s five years from being paid off.

One goal to consider is to pay at a rate that will have your mortgage paid off before you retire. My personal goal is ten years, so with that payment gone, we can reevaluate our retirement savings and increase to a higher level if needed. Or if we feel comfortable retiring early, at least that monthly payment will be long behind us.

Joe

  • Augustine November 19, 2009, 10:34 am

    I’ve refinanced the 16-year balance on my mortgage early this year down to 15 years, but in hindsight, in this economic climate, I should’ve refinanced in 30 years and pay as though it were a 15-year mortgage as you suggest. Were the worst to happen, including losing my job, I could fall back to the 30-year payment.

  • Evolution Of Wealth November 19, 2009, 4:58 pm

    I wrote a post called about how a 30 year mortgage beats a 15 http://evolutionofwealth.com/2009/09/15/your-mortgage-when-30-beats-15/

    I guess I just don’t see the rush in paying off your mortgage and the math supports that. I realize that there is a mentality to pay off debt but is this debt so bad. I just feel as though it should be the last debt you pay off and you should be in no hurry to do so. I, however, might just never pay it off.

  • Financial Samurai November 19, 2009, 5:56 pm

    I really prefer the 30-yr as it gives mortgage holders a “free option” to pay off earlier if they choose. Why cut off 15 more years of borrowing time, when you don’t have to?

    If you want to pay it down in 15 years, simple math gets everybody there.

  • JOE November 19, 2009, 7:33 pm

    CCC – you are right, the savings I show is typically 1/2% going from 30 to 15 yr mortgage. Not free, but not huge.

  • Credit Card Chaser November 19, 2009, 7:26 pm

    @FS

    Technically the “free option” is not so free because the cost is the higher interest rate for the 30 year vs. the 15 year mortgage.

  • No More Mortgage November 19, 2009, 9:19 pm

    When making a decision like this you should talk to a financial planner and look at the total picture. Joe brings some critical points to light above when he asks about carrying other debt, the current state of your retirement, and an emergency fund. Also think about the potential loss of the tax write off later which may or may not be a factor for you depending on your expected tax bracket at the point the mortgage would be paid off.
    One other thing to really think about is with the 15 year, you have to make a 15 yr payment. With the 30 year, you can pay more but you can always fall back on the lower 30 year payment in a financial emergency.

  • Augustine November 20, 2009, 10:35 am

    EoW,

    I don’t buy the “let’s spend more to pay less taxes”. You should know that spending 100 to get a discount of 30 one gets underwater by 70.

    Besides, there are some intangibles ignored in your analysis, such as market risk, change in fiscal laws, etc.

    Finally, an assumption that investments gain 6% is way optimistic. For example, in the last 15 years, the return on the S&P500 has been 2.4% (without dividends), or below the inflation rate.

    As a matter of fact, given the risk in both cases, I’d say that they are equivalent with no definite advantage between one or another, boiling down to one choosing what’s more convenient for him.

  • Financial Samurai November 20, 2009, 3:22 pm

    Good point CCC. That being said, the biggest spread I’ve seen is 25bps between the two, provided you have a great 30-yr fixed rate.

    I prefer the optionality.

  • Evolution Of Wealth November 20, 2009, 7:58 pm

    I don’t believe I ever mentioned “spend more to pay less taxes”. That wouldn’t make any sense.

    I never mention a specific investment that’s why I don’t address market risk or rates of return too much. It is meant to be more conceptual than a complete analysis. People’s situations are always different so I’m just trying to open people minds to ways to better their situation.
    If you go to http://en.wikipedia.org/wiki/S&P_500 they list a 15-year return as 6.46% and I would assume this includes dividends. Why wouldn’t you include that in your return? Unless you are investing in an EIA.

  • JOE November 20, 2009, 11:35 pm

    FS – In my example in the post, I show the spread as 1/2%, that’s what BankRate.com showed, and the same spread I saw when I refinanced to 15 yrs. Note: When I refinanced, the prior mortgage was 20 years, and I was about 2-1/2 years into it. The difference to drop from 17-1/2 to 15 was minimal, given the rate drop.

  • Augustine November 22, 2009, 2:12 pm

    Evolution,

    I didn’t include dividends because I didn’t have that number. But using Yahoo! charts, the last 15 years have been meager, as pointed out before.

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