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A Thought on 15 vs 30 year Mortgages

I’ve been reading many articles recently about the choice between 15 and 30 year mortgages. One of the interesting things that occurs to me is how years ago my “rule of thumb” was that a 15 year mortgage was only about 20% more than the 30. This seems to have changes as we can see.

First, I set the mortgage amount at $200,000, and then calculated the monthly payments at various rates for both 15 year and 30 year fixed rates. You’ll note that I use a 15 year rate that’s 1/2% lower than the 30 for payment comparison. You can see history going back to 1991 comparing the two showing that the average difference is about that much. (Note: the chart has a drop-down menu, choose the 36 yr chart)

Next, I simply divided, to find out the extra payment required as a percent of the original figure, to reduce the mortgage from 30 years to 15. What I find interesting here is that when rates were higher, for me it seems like yesterday, it took at little as 17% extra to bring a 10.5% mortgage down from 30 to 15 years. Yet with today’s relatively low rates it’s actually tougher to do this, the payment will be more than 40% higher.

The choice of mortgages is a tough one. There’s a movement away from debt, an almost “debt is evil” mantra. Yet, it comes when we live in interesting times, a combination of historic low rates, concern about employment, and fear of inflation around the corner. It’s for these reasons that I’d caution against prepaying at the risk of not having an emergency fund (as much as a full year of expenses) at the ready. It also bears repeating that one should never pass up matched 401(k) savings especially if your employer offers a dollar for dollar match.

Is your mortgage your only debt? Are you paying it off early? Let me know what your approach is, and why.

Joe

  • Augustine March 25, 2010, 9:09 am

    Joe,

    I refinanced my home last year from the remaining 16 years down to a 15 year term. In hindsight, because of inflation risks and fattening an emergency fund, I’d rather have refinanced for 30 years. This way, I’d have more margin of comfort to determine how much to prepay. Right now, I’m practically not prepaying.

    For similar reasons, the last car I bought, used, of course, I payed half of it and financed the rest at 2.9%, although I could’ve bought it outright, though at the cost of depleting my savings.

  • Evan March 25, 2010, 11:24 am

    The mortgage is not my only debt (student loans and a car note) so focusing on those first as they are smaller and have a higher rate, respectively. But I usually find that the flexibility with a 30 year mortgage with the option to prepay would most likely fit my style

  • JAL March 25, 2010, 1:24 pm

    My wife and I paid off our 5.5% mortgage completely last year. We arrived at that decision based on 1. We had saved the money up in non-retirement accounts, 2. We have no other debt, 3. After paying off the mortgage we’d still have an adequate emergency fund, 4. After considering the loss of the mortgage interest tax deduction we’d still net the equivalent of a guaranteed 4.3% rate of return on the money used to pay off the mortgage (something hardly assured when saved or invested elsewhere), and 5. We promised ourselves we’d continue to save at least the equivalent of our mortgage payment each month. So now we’re debt free and without a mortgage… doesn’t feel any different than before, except now we’ll never have to worry about cash flow! How did we do this? We live in a small house WELL below our means, have the discipline to SAVE as a top priority, and are careful about how we invest our money (we don’t chase high returns). Our next goal? Retire early! 🙂

  • RainyDaySaver March 25, 2010, 8:37 pm

    I know we’ve discussed this on my blog and at others — I’m of the same school of thought as you. My husband and I make sure we get our company 401(k) match, save a decent amount for retirement, and are building our emergency fund. At the end of April, we will have no credit card debt, and a car loan at 0% for another 4 years, which I do not plan to accelerate payments on. I am a fan of paying extra toward our 30-year mortgage to knock out some of the interest, but we only plan to use “extra” money in our monthly budget after all of our other bills and self-payments (401k, savings, EF) have been satisfied. It may not be a lot of money, perhaps $100/month, tops, but every little bit helps.

  • Evolution Of Wealth March 26, 2010, 5:55 am

    I like the different angle you take on the mortgage debate. I hadn’t looked at the difference between payment amounts and definitely think that there is more of a reason now than ever to choose the 30 year mortgage over a 15. In this environment, whether you want to accelerate your mortgage or not, I say go 30 year mortgage and take the responsibility of saving the extra money.

  • JOE March 26, 2010, 8:22 am

    Glad you enjoyed the post. Sometimes I have a thought but tough time getting it across in words. You got my point today.

  • Joe Plemon March 26, 2010, 9:28 am

    I appreciate this discussion because it forces us to get past the “One size fits all” mentality. I had been schooled in the Dave Ramsey mantra of ALWAYS get the 15 year mortgage, but even in advising my son on his home purchase I steered him toward a 30 year. Why? To give him and his wife some breathing room and more choices.

    After they bought their home, they became pregnant…my granddaughter is due in August!! Their finances will be tight, but they have the possibility of my daughter-in-law staying home with the baby. A 15 year loan would not have given them that option.

    Another quick thought/question: why do we limit our choices to a 15 year vs a 30 year? Why not a 10 year or maybe a 20 year mortgage?

  • JOE March 26, 2010, 12:00 pm

    Indeed, the 20 can be a nice compromise. One of my refinances was to go from the 30yr we had to a 20yr fixed. We had saved enough to make a large dent in principal, which when combined with the lower rate, meant the payment dropped as well. Two years later, as rates fell further, we moved from the 18 remaining to a 15yr which we have today.

  • Len Penzo March 26, 2010, 5:06 pm

    I faithfully paid down my debt with multiple extra principal payments each year for the last ten years, Joe. But last year I changed tack because I believe we will eventually be hit with high inflation – it is the only way I see how the government will be able to get out of this monstrous hole they are digging.

    Inflation is a friend to debtors – and a scourge to those of us with significant savings.

    With that in mind, I think it doesn’t make much sense right now to pay off a $110,000 loan at 4.5% interest if inflation is going to make that the equivalent of peanuts in five years.

    So I am now taking my extra mortgage payments and temporarily holding them in a high interest savings accounts until I get a bit more clarity on the inflation situation. At the first sign of inflation that money is going toward real estate, gold or silver.

    If inflation doesn’t pan out, then I’ll put it toward the mortgage.

    Best,

    Len
    Len Penzo dot Com

  • Sam March 28, 2010, 2:02 pm

    JAL – you annoy me. You forgot to mention that you have no kids. Anybody can easily do what you’re doing with two incomes and no kids.

  • JAL March 29, 2010, 12:33 pm

    To Sam:

    You’re right… we have two incomes. I also have two children and one cat!

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