- Why You Should Almost Never Choose a 15 Year Mortgage | B.E.S.T. Wealth Management
- Fear and Comfort
- Reason #1: Your Retirement Plan Supports It
- The Evidence
- 15 Year vs 30 Year Mortgage (at end of 15 years)
- 15 Year vs 30 Year Mortgage (at end of 30 years)
- Reason #2: Your Investment Won’t Return at Least 4.38% / Yr
- The 15-Year Mortgage: Pros and Cons
- What is a 15-year mortgage?
- Build equity faster
- Shorter path to full homeownership
- Long-term savings
- Larger monthly payments
- Opportunity cost
- Tighter range of home affordability
- Is a 15-year mortgage right for you?
- Why you should — and shouldn’t — get a 15-year mortgage
- Saving money
- Building equity
- An easier retirement
- An option that isn’t as disciplined
- 6 Ways To Know Whether A 15-Year Mortgage Is Right For You
- 2. You can reduce your interest rate by at least half a percent
- 3. You’re more than halfway through your 30-year mortgage and want to refinance
- 4. You can break even on your closing costs in three years or less
- 5. You haven’t refinanced in a while
- 6. You’d to retire mortgage-free
- Learn more:
Why You Should Almost Never Choose a 15 Year Mortgage | B.E.S.T. Wealth Management
Throughout the years, the vast majority of people I’ve worked with really want to pay off their mortgage in 15 years. Despite the deep down temptation to be pay off your mortgage early, I only see 2 reasons why you should ever go with a 15 year mortgage in today’s environment.
Fear and Comfort
It’s understandable why you wish to be mortgage free sooner rather than later. For starters, you don’t want to have a huge mortgage expense in retirement. And second, you don’t want to pay more in interest than you have to.
In other words, you have a fear of carrying a mortgage too long and you are comforted by your efforts to eliminate it fast.
These arguments certainly make sense from a financial and emotional standpoint, but as you’ll soon see, the 30 year mortgage is usually far better.
Reason #1: Your Retirement Plan Supports It
Despite my best efforts to convince clients of the superiority of the 30 year mortgage, the emotional pull for them to be debt free is screaming much louder at them.
In those circumstances, we only give them our blessing if their retirement plan supports it. You see, your goals should control all your decisions. If choosing a 15 year mortgage would jeopardize your retirement goal, then you shouldn’t go with the 15 year mortgage. Period!
However, if your plan works regardless of the mortgage length, then it’s perfectly acceptable to go with the 15 year option. But even in that situation the 30 year mortgage oftentimes superior.
Now, let’s look at some evidence.
As mentioned earlier, one of the major reasons people choose a 15 year mortgage is to reduce the amount of interest they pay. The effect of this is that you also build up equity at a much faster pace.
But are these valid reasons to choose a 15 year loan? No, and here’s why.
Assume you have a $300,000 mortgage. The 15 year interest rate is 2.75% and the 30 year interest rate is 3.25%.
The 30 year mortgage allows you to have a much lower payment ($1,306 / mo) than the 15 year mortgage ($2,036 / mo). And the difference between the two payments ($730 / mo) can be invested. It’s this investment piece that allows you to potentially make much more than you would have paid in interest.
In the chart below, we are looking at the first 15 years of the loan. If you chose the 30 year loan and you invested $730 / mo for 15 years, you would end up with $213,000 (assuming a 6.
00% per year growth rate) which is far more than the $66,000 in interest you would have paid on a 15 year loan.
And even though your equity is far lower, you still come out ahead with $27,000 more in your pocket by going with a 30 year loan.
This is great news because it means that even if you wanted to pay off your loan in 15 years, you would have more than enough money to do so. In fact, you’d have $27,000 left over.
So, if you absolutely must pay off your loan in 15 years, then get a 30 year mortgage, and use the investment proceeds.
15 Year vs 30 Year Mortgage (at end of 15 years)
Assumes a $400k home (with no growth) and a $300k mortgage. The 15 year rate is 2.75% ($2,036 / mo) and the 30 year rate is 3.25% ($1,306 / mo).
Savings for the 30 year loan assumes that you invest the difference between the 15 year and 30 year payment ($730 / mo) for the first 15 years and you earn 6.00% / yr.
But wait, it gets better.
If we play out the results over the full 30 year period, then your net worth is much larger as a result of having a 30 year loan.
This happens because you are able to invest $730 / mo for a full 30 years with the 30 year loan. Remember that you’re able to invest this amount of money since your payment is much lower than the 15 year loan.
The 15 year loan, on the other hand, only allows you to begin investing once the loan is paid off. At that point, you can begin investing $2,036 / mo from year 16 to 30.
What’s interesting is that even though you are investing more money with the 15 year loan ($2,036 / mo x 15 years = $366,000) compared to the 30 year loan ($730 / mo x 30 years = $263,000), you end up with far more savings with the 30 year loan.
In the chart below, you will notice that you accumulate $737,000 in savings with a 30 year loan compared to only $595,000 with the 15 year loan. That’s a whopping difference of $142,000 in favor of going with a 30 year loan.
So, even though you paid over $100,000 more in interest with the 30 year mortgage, you still come out $142,000 ahead! And imagine if you actually earned more than 6.00 % / yr on your investment. At just a 1.
00% increase to 7.00% / yr, the 30 year mortgage benefit increases from $142,000 to $247,000. This is why the 30 year mortgage is usually superior to the 15 year mortgage. It is a way for you to build wealth.
Dave Ramsey would convince you otherwise that you should NEVER get a 30 year mortgage. But I wholeheartedly disagree with this. But of course I encourage you to form your own opinion.
15 Year vs 30 Year Mortgage (at end of 30 years)
Assumes a $400k home (with no growth) and a $300k mortgage. The 15 year rate is 2.75% ($2,036 / mo) and the 30 year rate is 3.25% ($1,306 / mo).
Savings for the 15 year loan assumes that you invest your full payment ($2,036 / mo) from year 16 to 30 and you earn 6.00% / yr.
Savings for the 30 year loan assumes that you invest the difference between the 15 year and 30 year payment ($730 / mo) for 30 years and you earn 6.00% / yr.
Reason #2: Your Investment Won’t Return at Least 4.38% / Yr
Earlier I said that the savings provided by the 30 year loan allows you to “potentially” make much more money than the interest you would pay on a 15 year loan. In my examples above, I assumed you would earn 6.00% / year, but what if that doesn’t happen?
For sake of argument, let’s assume that your money is invested in the stock market. In the chart below, I am comparing the performance of 4 different segments of the stock market (US Large Company Stocks, US Small Company Stocks, International Large Company Stocks, and International Small Company Stocks).
If we assume that your money is equally invested in all 4 segments, then 83% of the time, your return was greater than or equal to 6.00% / year historically. But of course this means that 17% of the time your return was less than this. Nonetheless, the odds are significantly in your favor to earn at least 6.00% / year making the 30 year mortgage very attractive.
Perhaps you’re wondering what the minimum return would have to be on your investment in order for the 30 year loan to provide the same net worth as the 15 year loan. Let’s call this the breakeven return.
The best way to evaluate this is over a 15 year period as you may not be in a position to invest for the full 30 years.
In order to breakeven with the 30 year mortgage, you would need your investment to return at least 4.38% / year for 15 years. And as the chart shows below your investment would have earned 4.
38% / year or greater 93% of the time historically assuming you are equally invested in all four stock market segments.
So, if you don’t feel your investment will return at least 4.38% / year over a 15 year period, then by all means go with a 15 year mortgage. However, if you feel you can earn more than 4.38% / year, then you’ll find that you’re able to build significant wealth with a 30 year mortgage (especially if you earn the 11.96% / year average return of all 4 stock market segments).
# of 15 Yr Periods is measured monthly.
In summary, there are only 2 reasons why you should go with a 15 year mortgage in today’s interest rate environment – if your retirement supports it and if you don’t think you’ll earn at least 4.38% / year on your investment.
We are currently in a very low interest rate environment in our country and this is why the 30 year mortgage works so great and why the breakeven rate of return is so low.
When mortgage rates rise, so will the breakeven rate. This is why it’s so important to go with a 30 year mortgage today. We may not always have rates this low.
And you may not always have this opportunity to potentially build wealth over time.
I hope that you’ve enjoyed this article and it’s given you some things to think about. Please comment below and share how you have handled your mortgage(s) over the years. Do you prefer a 15 year mortgage or a 30 year mortgage? And why?
For more information on mortgages and other housing related topics, please check out our other articles.
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The 15-Year Mortgage: Pros and Cons
A 15-year mortgage is the dream home loan for buyers who can afford higher monthly payments and want to pay off their mortgage in half the usual time. A 15-year timeline can save thousands or even tens of thousands of dollars in interest.
To make a 15-year fixed-rate mortgage work, you’ll need a reliable income and enough money left after your monthly payment to cover expenses, savings and emergencies.
What is a 15-year mortgage?
A 15-year mortgage will be paid off completely in 15 years if you make all the payments on schedule. These mortgages typically have a fixed rate, which keeps the principal and interest rate the same for as long as you hold the mortgage. Your taxes and insurance costs can change, though.
In 2018, lenders wrote nearly 22 times as many 30-year home purchase mortgages as they did those with 15-year terms, according to NerdWallet analysis of Home Mortgage Disclosure Act data. Among loans for nonmanufactured, single-family homes, 3.6 million were for 30-year terms vs. roughly 165,000 for 15-year terms.
“The monthly payment on a 15-year loan is typically much higher than that of a 30-year mortgage.”
No doubt many borrowers shy away from these shorter home loans when they learn the monthly payment can be more than 50% higher — around $2,017 a month for a 15-year mortgage vs. $1,318 for a similar 30-year loan, for example.
Consider the pros and cons of 15-year, fixed-rate mortgages to decide which home loan is best for you.
» MORE: Compare costs for a 15-year vs. a 30-year mortgage
Build equity faster
A 15-year fixed-rate mortgage, with its lower interest rate and higher payment amount, builds home equity faster because you pay down the principal balance quicker.
Shorter path to full homeownership
Owning a home free and clear is a goal that burns bright for many people. What matters most to them is a feeling of safety from knowing that their home is fully paid off.
Lenders are exposed to fewer years of risk on a 15-year mortgage, so they charge a lower interest rate. Half as many years of payment also means you pay half as many years of interest. Let’s compare the principal and interest — not including homeowners insurance, property tax or private mortgage insurance — for a $250,000 mortgage with a 10% down payment:
- A 30-year fixed-rate mortgage at 3.61% has monthly payments of $1,024 and a total interest cost of $143,719.
- A 15-year fixed-rate mortgage at 3.13% has monthly payments of $1,568 and a total interest cost of $57,226.
That's a savings of $86,493 if you kept the loans for their entire term.
» MORE: See the best 15-year fixed mortgage lenders
Larger monthly payments
Monthly principal and interest payments for a 15-year fixed-rate mortgage run about 50% higher than on a 30-year home loan.
You also have to pay property taxes, insurance and, if you put less than 20% down, mortgage insurance. This could make it hard to respond to emergencies and other needs.
Even if numbers seem doable now, a mortgage is a commitment. Getting out means selling, refinancing or foreclosure.
Nerdy tip: If you're unsure that you'll always be able to make bigger payments, choose a mortgage with a longer term and opt to pay extra toward the principal each month. That way, you're still paying down the mortgage more quickly, but you aren't in hot water if there's a month where you can only make the minimum payment.
Using more money for monthly mortgage payments means it’s not available for other investments such as home improvements or capturing an employer’s matching contribution to a retirement account.
» MORE: Should you pay off your mortgage or invest?
Tighter range of home affordability
The higher monthly payments for a 15-year mortgage mean you’ll qualify for a less expensive loan. That might mean buying a smaller house or forgoing your dream neighborhood. Stretching the loan over 30 years and keeping your payments low could give you more choices.
Is a 15-year mortgage right for you?
A 15-year, fixed-rate mortgage is a great tool for borrowers who can afford the higher payments while still saving and investing for retirement. Paying off a mortgage gives many people a feeling of independence, safety and accomplishment.
But if your income is uncertain or variable, avoid the 15-year mortgage. Ask yourself: What would happen if the payments become too much? Do you have a realistic plan to cope, or would you stretch your finances too far?
Why you should — and shouldn’t — get a 15-year mortgage
A home is ly to be the largest purchase of your life. Coming up with a down payment can be hard enough, so spreading out the mortgage payments over 30 years can make a home a lot more affordable. Cutting that time in half with a 15-year mortgage probably won’t be a possibility with your first home.
But later in life, when you’re earning more money, have more equity and plan on staying in a house for years to come, refinancing into a 15-year mortgage can make sense.
As anyone who has looked at a mortgage statement or closing papers on a house knows, the interest paid on a 30-year loan can be almost as much as the principal paid over the life of the loan. That’s one of the first reasons to consider getting a 15-year mortgage.
It can be difficult to take the long view when looking at a monthly mortgage bill that will be 50 percent higher over 15 years instead of 30.
“For the most part, homebuyers are trying to get the lowest monthly payment,” says Rick Bechtel, executive vice president and head of U.S. mortgage banking at TD Bank in Mt. Laurel, N.J.
Paying a home loan off in half the time requires a larger payment, of course, that will save you tens of thousands of dollars, if not $100,000, on interest charges. Why? Not only is more principal paid earlier, but interest rates on 15-year mortgages are usually better than other types of loans.
Bechtel gives the example of a $200,000 mortgage at 30 vs. 15 years:
Mortgage type: 30 year 15 year
Interest rate: 4.5% 4%
Monthly payment: $1,013 $1,479
Total interest: $164,813 $66,288
That’s almost a savings of $100,000 by going with a 15-year loan. Divide that savings over 15 years and it’s about $555 saved per month.
It would be nice if that $555 in monthly savings was in your pocket from the beginning. But it’s not. It’s the savings you’ll see after the loan is paid off.
The main difficulty with a 15-year loan is increasing your monthly payment. In the above case, it’s by $466. Putting that $555 monthly savings into the mortgage would more than pay for it.
But where do homebuyers get money now so they can afford a much higher mortgage each month for the next 15 years?
Because less than 10 percent of homeowners have 15-year mortgages, Bechtel says it’s not an option for everyone, mainly because of the higher payments.
“It’s not for the faint of heart,” he says.
Borrowers should make sure they have enough income to afford it, are able to manage their household debt, and have money in liquid savings for emergencies, he suggests. This is mainly why 15-year mortgages are more of a refinancing option, says Bechtel, who bought his house with a 30-year loan and later refinanced into a 15-year loan that now has six years remaining.
“If I’m going to swallow a bigger monthly nut, knowing that I’ll save a ton of money in the long run,” Bechtel says, a borrower needs confidence in their job prospects or have enough money in savings to cover the higher mortgage if they lose their job or their salary drops.
Repaying a mortgage faster not only saves you money in the long run, but you build equity in your home faster too. If home prices rise, equity could grow more.
This is good for many reasons, including making refinancing easier by lowering your debt-to-income ratio. While it won’t improve your cash flow, it should make it easier to be approved for a home equity loan or home equity line of credit, Bechtel says.
A home equity loan can be used to help pay for college, for example, and repaid if you need the equity back.
An easier retirement
Another big advantage of cutting a home loan timeline in half is that if you plan to retire in the next 10 to 20 years, having your home paid for when you retire won’t hurt your finances in retirement. Instead of a house payment, you can use that money for retirement expenses.
If you continue paying a 30-year mortgage in retirement, you may have to pull money your savings to make the payments.
An option that isn’t as disciplined
If you can afford it, a 15-year mortgage is a forced form of discipline of paying off your home early.
But if you’re unsure if you can make the higher monthly payments for 15 years, one option is going half way by keeping a 30-year fixed mortgage but paying it off in 15 years, Bechtel says. It will give you flexibility in paying the higher amount when you can afford it, and cutting back to the normal, 30-year payment amount when you can’t.
The 30-year mortgage will have the higher rate — 4.5 percent in the example cited above by Bechtel — but paying $1,530 per month instead of the regular $1,013 payment will pay off the mortgage in 15 years. Only $75,397 will be spent in total interest, which is $9,109 more than with a 15-year mortgage, and $89,416 less in total interest paid than with a 30-year mortgage.
You’ll need to be disciplined to make the $500 in extra payments each month, but can do that with automatic payments.
“Now you are just into the beauty of forced savings,” Bechtel says.
6 Ways To Know Whether A 15-Year Mortgage Is Right For You
With mortgage interest rates moving up from historic lows, 15-year loans are getting more attention. Their lower rates compared with a standard 30-year mortgage make them a good choice for buyers and homeowners looking to refinance.
If you’re researching mortgages, a 15-year loan is definitely worth considering. Here are some ways to know if a 15-year mortgage is the right fit for you.
By far the biggest drawback to a 15-year mortgage is the higher monthly payment compared with a 30-year loan. Yes, 15-year mortgages tend to have lower interest rates than their 30-year counterparts, but because you have to pay off the balance in half the time, you wind up laying out more each month while you’re making those payments.
“That’s usually where everyone’s stress is. It’s not necessarily that they can or can’t afford it as far as the lender is concerned, it’s, can they deal with it in the family budget?” said Jeff Lazerson, president of MortgageGrader.
It’s important to do your homework and analyze all your costs. You’ll save a ton of money in the long run by paying less interest overall on a 15-year mortgage, but it may not be worth maxing out your monthly budget to get that savings.
“If thinking about it doesn’t keep you up at night worrying,” Lazerson said, you’re probably in a good position for a 15-year loan.
2. You can reduce your interest rate by at least half a percent
Lowering your interest rate is a great reason to consider a 15-year mortgage, but it can be an expensive proposition if you’re not getting a good enough rate.
So, make sure to shop around for the best rate and analyze every offer you receive. Currently, 15-year mortgages average 2.52 percent, versus 3.18 percent for a 30-year. These rates include some points and fees.
“If it’s just a little bit better than what you have, you can always wait and see, but if it’s significantly better, say, half a point or more in interest rate, don’t wait,” Lazerson said.
You shouldn’t hesitate just because you want to find the absolute bottom of the market, which probably happened in January. You could miss out on good offers and significant savings if you wait too long.
3. You’re more than halfway through your 30-year mortgage and want to refinance
When you refinance, you start the repayment clock again as soon as you close on your new loan. If you’ve already been paying toward a 30-year mortgage for 15 years or more, you may not want to refinance into a new 30-year loan, because doing that would extend your repayment period significantly and you would have to pay even more interest overall.
However, by refinancing a 30-year mortgage into a 15-year one, you’ll keep your payment timeline the same and will reduce the amount of interest you wind up paying.
4. You can break even on your closing costs in three years or less
The breakeven timeline is a key thing to think about with any mortgage refi.
Refinancing comes with a variety of closing costs and other fees that eat into your savings at first. Lazerson said it’s not usually worth it to refinance if it’s going to take too long to recoup those costs.
“If you can recoup your costs in three years or less, it almost always makes sense to do it unless you’re going to sell in less than three years,” he said.
“It’s really hard to look at your horizon beyond three years,” he added. “You might get a job transfer, you might end up hating your next door neighbor and you want to move.
Maybe you want to do a room addition on your house and you’re going to refinance later anyway.”
Not recouping your costs soon enough could put you in a more precarious financial situation down the road if an unexpected expense comes up, or if you need to change your housing situation on short notice.
5. You haven’t refinanced in a while
Thanks again to the ongoing trend of low mortgage rates, most current homeowners stand to save by refinancing if they haven’t done so in the last year.
“Rates have gone down so much in the last 12-24 months even, if you did a loan a year ago, you’re probably in a good opportunity to save money,” Lazerson said. “If you did something prior to March or April of 2020, you should really look at it again.”
Interest rates are still low enough that some mortgage holders who refinance old 30-year loans into new 15-year ones can actually keep their monthly payments pretty similar.
“People are able to shorten the amortization period,” Lazerson said, and the result is savings you don’t have to think about. “The beauty of the 15-year is the forced discipline,” he said.
6. You’d to retire mortgage-free
There’s no better way to boost your retirement outlook than to have your mortgage paid off when you stop working. If you have a mortgage now that stretches many years into your expected retirement, you’d be wise to look at a new and shorter-term mortgage that can be paid off by the time your paychecks stop.
For people aged in their mid-40s to 50s, refinancing now into a 15-year mortgage guarantees you’ll have a lot more room in your monthly budget if you want to retire in your 60s.
Just make sure your current budget can accommodate the higher payments.
If you’re not sure, it might be best to make additional principal payments on your current mortgage so you’ll have the flexibility to cut them back if times get tough.
That said, if your current interest rate is a half-point or more above what you could get now, refi into a new 30-year mortgage and you’ll cut your interest costs. Then you can direct the savings into additional principal payments.