In this post, we’re talking about a 15-year vs 30-year mortgage, which one is better? Read this post to find the right answer for you.
Today, we’re comparing the pros and cons between a 15-year mortgage and a 30-year mortgage.
Buying a home is one of the biggest purchases you’re ever going to make in your lifetime. So it really depends on what kind of mortgage you get.
The ideal situation is to pay for a home in cash but a lot of people don’t have that kind of money lying around.
What’s a Mortgage?
A mortgage is a loan against your home using the home as collateral. So if you don’t pay that mortgage the bank has recourse and they can kick you out of your house. This is known as foreclosure.
30-year mortgages are the most common. With about two-thirds of applications being for 30-year mortgages. And upon final closing, the statistics show that 30-year mortgages are used 86% of the time when closing.
The 15-year mortgage at this point sounds like the ugly duckling of the bunch. Because the 30-year is so much more popular but that’s not necessarily true and I’ll show you why.
The 15-year mortgage
Let’s start with some of the Pros:
The banks will give you a lower interest rate on a 15-year mortgage. The reason for this is because it’s less risky for a loan.
So what does that mean and why is it less risky?
It’s less risky because the term is shorter. Say for example:
You’re a banker and you’re lending someone money to buy a home. It’s less risky as a banker because the duration is not as long as a 30-year mortgage. There are fewer things that can happen to you whether it’s job loss, sickness, and even death.
So a shorter-term mortgage is looked at as less risky to the banks.
The interest rates are also typically 0.25% to 1% lower than a 30-year mortgage. You can also pay these off in a shorter amount of time
You got faster principal paydown as well.
So what this means is the principal of a loan is the amount that you actually borrow. Say for example you borrow $100,000 as a mortgage. The bank adds interest on top of that $100k as well.
Basically, you have two parts to the mortgage or two parts to the loan. You have the principal and the interest.
With a 15-year mortgage, more of your monthly payment goes down towards the principal paydown. This means you’re actually paying off the loan faster as opposed to a 30-year mortgage.
At the beginning of a 30-year mortgage, the majority of your monthly payment is actually going towards the payment of the interest, not the principal.
Now that I’ve touched on some of the pros of a 15-year mortgage here is the one biggest con.
Having a higher payment every month
It just makes logical sense. If you’re still borrowing the same amount of money let’s use that $100,000 for example, obviously, your payments are going to be lower if you stretch it out over 30 years rather than stretching it out over 15 years.
It’s just math. However I will get into some of the reasons why some people may actually prefer the 30-year mortgage with a lower payment rather than having this con of the higher payment of a 15-year mortgage.
The 30-year mortgage
Now, that we’ve talked about some of the pros and cons of a 15-year mortgage let’s get into some of the pros and cons of a 30-year mortgage.
Having a lower monthly payment.
So the lower payment actually allows you to purchase more home than you can originally afford with a 15-year mortgage. Again, because your payments are stretched out over 30 years.
This also frees up more funds for you to invest. So as long as you’re earning more interest in your Investments than what the interest is on your mortgage. That means you’re netting a positive return.
Think about it logically; If your interest rate on a 30-year mortgage is 4% and your Investments are earning you 7%. That’s a difference of 3% over the course of that 30 years. But again, that takes a lot of discipline to do
Some investments you make are in the stock market, or you put it into a 401k with an employer match, or you can even put it into a 529 plan for your child’s future education.
It takes much longer to pay off
It’s obviously a longer mortgage by 15 years when comparing it to a 15-year mortgage. This could actually last you until retirement. If you ask for my personal opinion I don’t want to be paying a mortgage into my retirement.
Slow principal paydown
As I mentioned earlier in the 15-year mortgage. Those principal paydowns are a lot quicker because a majority of your monthly payment is going towards the principal of the loan, not the interest.
In the case of a 30-year mortgage, a majority of your payments are actually going towards the interest first then the principal.
So you’re not building a lot of equity in this process
15-year vs 30-year mortgage
Now, let’s talk about investing the difference between the two payments of a 30-year mortgage vs a 15-year mortgage.
Let’s go through a real-life example with real numbers:
I’m doing this just for simplicity. We’re not going to do any math but you’ll be astounded at the difference of interest in a 15-year mortgage vs 30-year mortgage.
So let’s say I want to buy $375,000
In order to put 20% down on this house, we’re going to end up putting down $75,000 as a down payment. If you take out $75,000 that you’re putting down your mortgage on this house is $300,000.
The 30-year loan is probably going to be right around 4%, let’s just use 4% for easy numbers.
The 15-year mortgage is going to be about 3.25%. The interest over the course of a 15-year loan at 3.25% is $79,441. Now, you’re probably thinking to yourself if I just double that, because the 15-year loan * 2 then the interest rate is just going to be $79k * 2 right?
Well, you’re actually Wrong!
The 30-year loan interest that you’re paying over the course of those 30 years is $215,609. That’s a difference of $136,000.
So you have to really ask yourself am I going to be disciplined enough to consistently invest that difference in order to make up for having such longer or higher interest payment.
Now, if you take the two payments:
The 15-year loan payment is $2,108. The same loan on a 30-year payment is going to be $1,432. That’s a difference of $676.
Now, let’s go through a real-life example. If you were disciplined and invested that $676 over the course of 30 years:
If you invested that at 7%. Let’s just say you’re earning the market average of 7% over the course of your lifetime. This accounts for bull markets, bear markets, war, or whatever.
30 years at 7% gets you $829,511 pre-tax. If you were to put that same amount in a tax-free account you’re going to end up with $558,179.
Do you see how powerful that is!
So if you have the discipline to invest that difference between your payment of a 15-year and a 30-year mortgage you’re obviously going to net a lot more money over the course of 30 years. However, life happens to everybody and it’s pretty difficult to have that discipline like. That usually ends up in a vacation, a new car, or a college education fund.
So as long as you have the discipline it makes more sense to take the 30-year mortgage and invest the difference.
Or you can have the best of both words
What I mean here is you take a 30-year mortgage and pay it off like a 15-year.
You still get into the house you want where you can afford the payments of a 15-year mortgage but you choose to take the 30-year. This enables you to pay off the home like a 15-year mortgage but it still gives you a cushion for when life happens
If your car breaks down and that cost a $1,000. You can take that cushion and instead of paying your mortgage off like a 15-year mortgage for that month you can decrease the payment, still pay for your car, and still be on time with your mortgage payment.
That way your credit is preserved and you’re getting the best of both worlds.
There are clear advantages to both 15-year and 30-year mortgages but keep in mind it is called Personal Finance for a reason, there’s no one-size-fits-all.
Personal finance should be personal to your life and your life situations.
In my opinion, if you’re disciplined you should take a 30-year mortgage and invest the difference between the payments because this will put you in a better financial situation.
If you’re not disciplined you should take a 30-year loan and pay it off like a 15-year mortgage. This way you pay it off early and still have plan B for when life happens.
If you’re interested in paying off your mortgage early I made a post about it. You really should read it. How to pay off your mortgage early?
Thanks for your time
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