Why a 15 Year Mortgage Isn’t Always the Best Choice

by Kevin M on December 12, 2012

in Housing

With mortgage rates being at all-time lows many homeowners are looking to take the rate bonanza a step further by going for a 15 year mortgage. Not only will you pay off the mortgage in half the time, but you’ll get an even lower rate for doing it.

Sounds like a good deal right? Not necessarily, and certainly not for everyone.

15 Yr vs 30 Yr Mortgage

Payment Shock With A 15 Yr Mortgage

Right now, you can get a 30 year fixed rate loan for around 3.25%. You can also get a 15 year fixed rate for just 2.75%. As far as rates are concerned, comparing the two is the perverbal “no brainer”, right?

No so fast.

In a pure mathematical sense, rates matter a lot. But real life and math equations are two very different things. In the real world, rates matter mainly as a tool in reducing a monthly payment. But in this comparison—the lower rate of the 15 year mortgage will not reduce the payment.

No matter what the rates are on either loan type, the payment on the 15 year loan will always be higher than it is on the 30 year loan.

If your mortgage balance is $200,000, and you refinance to a 15 year loan at 2.75%, the monthly payment will be $1,357 per month. If you refinance the same loan amount for 30 years at 3.25%, the monthly will be only $870. That’s a difference of $487 per month! How does an annual rate savings of .50% look against a monthly payment that’s nearly $500 higher?

Put another way, the payment on the 15 year loan is more than 50% higher than it is for the 30 year. You’d have to think long and hard about whether or not that’s an advantage. For most people, it will be more of a nightmare.

No Immediate Benefit From A 15 Year Mortgage

This is another point that I don’t think most borrowers fully appreciate. While it’s true that you’ll pay off a 15 year mortgage in half the time that you will a 30, there will be no immediate benefit for doing so.

You will have to make the higher monthly payment for 15 years—that’s 180 monthly payments—before you’ll see the fruits of your labor.

When you sign up for a 15 year mortgage, you lock in the higher payments for the entire length of the loan. The payment will remain fixed for the entire term. Yes, you will be paying your mortgage off much sooner, but the day-to-day cost will be substantial.

With 15 year mortgages, virtually all of the benefit of the loan comes at the very end, when the house is owned free and clear.

There’s No Turning Back

Along the same line, once you take on a 15 year loan, you’re locked into for the duration. Yes, it will pay your mortgage off sooner, but if you lose your job or face some other financial disaster while the loan is still outstanding, the higher payment will sting.

You won’t be able to call up your lender and say “we made a mistake, can we go back to the 30 year loan?” Yes, you can refinance, but if you have no job or your credit has deteriorated since closing on the loan, you may not qualify for a new one.

15 years is a very long time when you’re making a high payment.

The Disappearing Income Tax Deduction

One of the biggest benefits of having a mortgage is that it’s one of the last solid tax deductions available to the average taxpayer. Medical deductions are reduced by 7.5% of your adjusted gross income, and credit card- and auto loan-interest aren’t deductible at all. But mortgage interest remains fully deductible. That can be a substantial tax savings, especially for high income taxpayers.

But since a 15 year mortgage pays off quicker than 30 year loan, they also make the tax break go away sooner. It’s not just the loan balance that goes away—the tax deduction goes with it.

Neglecting Other Financial Needs

When it comes to 15 years mortgages, there’s a definite opportunity cost. In the example above of the payment difference on a $200,000 mortgage, the payment on the 15 year loan was higher by $487 per month. That’s almost $6,000 per year!

That begs the question: what else could you be doing with $6,000 each year?

How about paying off a car loan, paying off credit cards, funding a Traditional IRA or Roth IRA, building up emergency savings, funding college plans for your children, or retiring student loan debt?

All of these are at least as worthy as paying off your mortgage early, and most of them will be more immediate in their impact. $6,000 per year could be putting out a lot of financial fires and/or funding a lot of accounts. By loading all of it onto a single venture—paying off your mortgage in half the time, you deny yourself access to the money to do other things.

That’s opportunity cost, and it’s a factor with a 15 year mortgage.

photo credit: Freedigitalphotos.net

© 2012, KNS Financial, LLC. All rights reserved.

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{ 21 comments… read them below or add one }

1 Rich Uncle EL

I can appreciate the view point that you make in the post, and I think people have to make a final decision on the various options for a mortgage. If your income is steady and derives from self-employment that you control then take on the 15 year mortgage as long as it is below the 36% max household limit. If you work for others then you can be fired at a moment’s notice, then go for the 30 year but make biweekly payments, so that you can have the best of both worlds. This should reduce your payoff term to 21 years.

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2 Kevin@OutOfYourRut

Hi Rich–I’ve often thought that the 15 year is best suited to goverment employees and healthcare workers. They’re just about the only broad categories who have job security any more. I even think the 30 year is better for the self employed so that you keep your options open (maybe take a 30 year loan, but make payments based on a 15 year payoff).

Good thought on the biweekly. I was thinking it would be easier on cash flow as well. Coming up with a single large house payment every month would be tough if you’re unemployed, but the biweekly would lighten the burden a bit.

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3 Suter

It’s funny that people who want to assure themselves that their 30y mortgage is the best option like this article and those who think paying off your debt early have concerns.

When people think short term, they will like lower monthly payments, even though they will be paying significantly more in interest over the course of the loan. That’s because they don’t see far to the future. And they probably will need a home for the next 30 years.

Those who are thinking long term see that higher monthly payment will actually reduce the total intrest they are going to pay. A lot.

At the end, someone needs to pay for Wall Street bonuses. It’s up to you if you want to do it for 15 or 30 years.

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4 Kevin@OutOfYourRut

Thanks for your comment Suter, but you may be overcomplicating this a bit. It’s not really about Wall Street, it’s more about Main Street. In point of fact, jobs are no longer as secure as they used to be. Whether it’s a 15 or 30 year loan, you will have to survive that span in the best way possible. The 30 year offers the lower payment with greater flexibility. I wouldn’t trade either in this economy–and this is supposed to be an economic recovery!

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5 Suter

Reference to Wall Street was just a translation of where your interest eventually ends up.

You need to have a job to get a mortgage. I would advise to build someone’s net worth as fast as possible while they have a job. You never know what will happen in 5, 10, 15 years. Even if they get to sell the house, their equity will be much higher.

Most Main Street people is not going to save the difference between the 15 and 30 years monthly payments. They will spend it. It’s a loose – loose situation for them in a long run.

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6 Carla

I came here from Free Money Finance…

This is the best article I’ve read in ages. The ridiculous trend in PF blogs to always go for the shortest term mortgage possible is absurd. People see rates, and that’s all. Thank you for a hefty dose of common sense.

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7 Kevin@OutOfYourRut

Hi Carla–Thanks for the compliments. I think that any time you divorce real life/human nature from the financial picture, you’re doing people a disservice. We’re not lab rats participating in an experiment. We’re real people undergoing the ups and downs that real life throws at us. Sure it’s great to be able to pay off your mortgage in half the time, but that won’t help you if you lose your job in year #3 of a 15 year mortgage. That’s happening more and more these days.

I also saw a fair number of people who refinanced 30 year loans to 15, only to go back to a 30 a couple of years later when life got in the way. When you’re in the mortgage business you see that kind of situation and it makes you step back and think about the conventional wisdom.

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8 SteveD

Great article! For my investing strategy, I agree with your philosophy, but for only the last reason that you list — the opportunity cost. Payment shock and no immediate benefit are not good excuses for anyone with discipline and financial planning. Saving more on taxes just means that you’re spending more on interest; I never bought that argument.

However, at current rates, I believe that I can get much better returns than 3.5% in other investments (particularly if inflation picks up), and the longer that I can borrow the most money at that rate, the more I can do with it. Both the stock market and real estate make better than 3.5% in the long run. If you have ANY other debt that at a higher rate (student loans, credit cards, car payment), you’re better off to get a mortgage at a lower rate and use the monthly savings to pay those off. Furthermore, imagine if inflation ever goes above 3.5%, I’ll be MAKING money on my loan! We will probably never see rates this low again in our life time (since they’re a response to the biggest recession of our lifetime), and recessions are when millionaires are made!

While it would feel good to be debt free sooner, I run my real estate investments like a business, and with these historic rates it makes much more sense to get the maximum leverage for the longest time. But that’s my personal strategy; it wouldn’t work for everyone.

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9 Paul D

I agree that a 15yr mortgage isn’t always the best choice. A zero yr mortgage is the best choice. 100% down payment! Unfortunately most people won’t go this route.

The amount of interest paid between a 30yr and 15yr loan is too big to ignore. If you can’t afford a 15yr mortgage, maybe you should consider a cheaper house, or wait longer and build up a bigger down payment.

Most people won’t be disciplined enough to pay extra on a 30yr mortgage. Stuff happens to suck away that extra money and it ends up being 30yrs before the mortgage is gone. A 15yr mortgage forces you to get it over with in 15yrs and save A BUNCH of money.

The advantage of having a tax write off…hmmm…. If you pay $10,000 in interest and are in the 25% tax bracket, you’ll get a $2,500 reduction on your taxes. If you have no mortgage you have no tax write off so you’ll pay $2,500 in taxes on the $10,000 you didn’t pay to the bank and you’ll have $7,500 in your pocket! If you want the write off, give the $10,000 to your church!

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10 My Wealth Desire

Nice one. I will go to pay off early mortgage, because I don’t want to have a dead contract with my home. What is the difference or financial impact of paying off 15 or 30 years/

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11 Amanda L Grossman

It’s interesting reading an opposite viewpoint to how I feel! Good points.

We refinanced from a 30 year to a 15 year mortgage earlier this year, and I couldn’t be happier. We went from 5.5% to 3.5%, and our monthly payment only increased by $200. So for an extra $200 per month, we will be debt free fifteen years sooner. That’s incredible to me! The closing costs were only $400 (and we did not tack on the rest to the mortgage; we literally only paid $400 in closing). And as Money Beagle said, we are building equity so much faster (our payments before put $120 towards principal each month; our payments now put $621 towards principal each month–incredible!)

We also have paid off all of our non-mortgage debt, and fully fund our Roths each year. So for us, the decision was simple.

But I can certainly see how others may wish to think about the 30 year mortgage instead of a 15 year mortgage.

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12 Kevin@OutOfYourRut

Hi Amanda, I agree that it can work for some people, but it should never be seen as a “no brainer” for everyone. When I was in the business I did a fair number of refinances moving people out of 15 year mortgages and back into 30 years. The higher monthly payment can be a grind on the budget, but never more than when a job has been lost or a significant new obligation arises.

If you can be absolutely certain that you’re financial situation will be stable or improve, a 15 year mortgage is the way to go. But that kind of certainty isn’t out there for a lot of people any more. Flexibility is super important right now.

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13 JoeTaxpayer

Kevin – you make some excellent points. I’d suggest that there’s a set of priorities people should have when it comes to faster debt repayment. (a) A matched 401(k) should always be the first priority, even before paying off the 18% credit card sooner, (b) next comes the high interest cards, (c) the lower interest debts including the car loans, (d) the emergency fund. Even after one has a years’ expenses saved in the emergency fund, I’d think long and hard before going 15 on the mortgage.
The better choice, in my opinion, is if the 3.25% rate feels like an appealing rate of return, make partial principal payments, and start to pay the mortgage early. Rates are artificially low, and likely to rise, even if after a few years. How would you like to be depositing money into 6-8% CDs while paying the bank 3.25% every month?
With inflation still over 2%, this is the cheapest money one may ever see in their life, it’s close to free.
When people simply add interest over a 30 year period, it’s clear they are ignoring the time value of money. That last dollar you pay in 30 years will be paid with 25 cents in today’s money.

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14 Kevin@OutOfYourRut

Joe, you raise another outstanding point, interest rates are at historic lows. Locking in 3.25% for 30 years will free up a lot of capital to be invested at higher rates in the future, when they return to historically normal levels. People have forgotten that you used to be able to get 6-8% interest rates on risk-free investments.

Right now rates are artificially low (Fed buying up debt to keep them low) but that won’t last forever. No one will want to pay off 3.25% money when rates are double that.

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15 Max

I recently refinanced my mortgage and decided to go with a 15-year term over a 30-year term, because for me personally, I would rather have the long-term savings than the immediate reduction of my monthly payments.

However, I believe a lot of it comes down to how much of a difference the monthly payments would be, and simply whether or not you can afford it.

My remaining balance was around $75,000 with a monthly payment of about $460.

After refinancing, a 30-year term would have payments of around $340 and a 15-year term at around $515.

Since the difference was only around $150 between those two options, and I was already paying close to $500 with my prior interest rate, the 15-year term was a more sensible option for me, because the payment difference wasn’t huge, and the long-term savings would be better.

You just really have to judge what you can afford in the long term.

At the same time, you could always go with the longer term, if you were afraid of being unable to make larger monthly payments, and then just pay off extra money toward the principal on monthly basis as you can afford it.

You won’t save as much in the long term doing this as you would by going with a shorter term, but then you can always stop paying more toward the principal if you ever can’t afford it.

Anyway, thanks for the article, I just did my refinance last week, so I found it of interest.

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16 Kevin@OutOfYourRut

Hi Max, In your case, the 15 raised your payment by $55/month. No offense but that’s an easier decision than if your current payment is $1200 and refinancing to a 15 yr would bump the payment up to $1500-$1600.

Going with a 15 makes more sense on smaller loan balances, because the payment shock is much less. On larger loan amounts, it can get scary!

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17 Max

No offense taken, that was basically my point, that since my payment difference wasn’t huge, it was a no-brainer decision.

I’m not saying a 15-year term is better than a 30-year term overall for everyone.

I think it’s all relative to what you can afford, as a $300-$400 increase in monthly payments could be chump change to some people, but unaffordable to others.

If I had a $1500 per month mortgage right now, I’d be going crazy making the payments, but that’s the reason I bought a house in the $100,000 range I suppose, you should buy what you can afford (or at least hope to afford).

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18 Money Beagle

You are incorrect about not seeing an immediate benefit. A 15-year mortgage means you are applying a lot more toward principle each month. That will increase your net worth. In your example, you might be paying that extra $450 a month but it could mean a $700 in what you are actually applying toward principle. If so, that’s a $250 per month bump in your net worth that takes place…immediately. And it adds up higher and higher over the entire time you are paying the mortgage as you build equity so much faster since you’re putting a much higher percentage of payment toward principle (which is a cash outflow but only a net worth transfer) versus interest (which is a negative to your net worth)

You’re right, there is a definite cash flow issue between the two, but if you can swing the difference, the benefits are well worth it in my opinion.

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19 Kevin@OutOfYourRut

Hi MB–I completely agree with the long term equity build up from a 15 year loan. But 15 years is still a LONG time to be making higher house payments. A lot of other financial needs will go unmet during that time.

The other issue we have to be concerned with today is job security. It isn’t what it was a few years ago, and the higher house payment could be a back breaker in the event of a long period of unemployment, or a career retrenchment.

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20 Steve

Kevin,
I just started following you on Twitter and this is the first post I have read on your blog. I say that to say my point below is not to prove your points wrong, but just throw out a different view for discussion sake.

While I think your point to consider the impact of the higher payment of a 15 year vs. 30 year mortgage to your monthly budget is very wise, I come to a different conclusion from your example. While I agree that math is only a part of the equation, I still would not want to pay out $113,000 in interest ($200,000, 30 yr, 3.25%) instead of $44,000 in interest ($200,000, 15 yr, 2.75%). So, why not start with your monthly budget and determine what you can afford each month for a house payment? If a payment over $870 per month is too high, then why not decrease the amount of house you are buying? Or if someone does not have the extra money in their monthly budget to pay down debt or contribute to retirement, then maybe they currently have too much house and need to downsize for a short time period. Rates may matter mainly as a tool in reducing a monthly payment in the real world, but I do not want to be like most people in the real world who are deeply in debt. If I am going to reduce my rate then I want it to make more money long term and not reduce my monthly payment. My goal is to be debt free. My goal is to make my tax deduction disappear. Yes, I will take the deduction as long as I have a mortgage, but I am not going to use it as a reason to extend my mortgage. There are lots of people paying $10,000 per year in interest to avoid sending the IRS $3,000 in taxes.

I look forward to reading your future posts. And by the way I am currently in the process of losing 30 pounds (235 to 205).

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21 Kevin@OutOfYourRut

Hi Steve–A point of clarification, this site is Khaleef’s, not mine. Khaleef has brought me on board as a staff writer.

On to the 15 year term…I would agree with you if interest payments were the only concern, but they aren’t. First of all, $113k in interest for the 30 vs $44k for the 15 is at least partially nullified by tax deductibility. You also have to factor in the opportunity cost on the extra money going to the 15 year loan. If you’re paying off a mortgage at 2.75%, would you not be better off paying off a car loan at 5% or a few credit cards at 14%. And what about the advantages of higher liquidity that come from having more cash to put into savings? These are impossible to quantify with mathematical precision, but they’re worth considering.

On a more practicle level, can you be certain your income level will accomodate the higher payment for 15 years? When I was in the mortgage business I always told people to take a 30 year loan and pay it at a 15 year paymennt level. You can pay off the loan in 15 years, but if you lose your job you won’t be locked into the higher payment.

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