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, Kevin M. All rights reserved.

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