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)
|15 Year Mortgage||30 Year Mortgage|
|TOTAL Equity + Savings||$400,000||$427,000|
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)
|15 Year Mortgage||30 Year Mortgage|
|TOTAL Equity + Savings||$995,000||$1,137,000|
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 like 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).
|Stock Index||Years||# of 15 Yr Periods||% of Time Return >= 6.00% / Yr||% of Time Return >= 4.38% / Yr||Avg Return|
|US Large Company Stocks|
(S&P 500 Index)
|1/1/1926 – 9/30/2020||958||83%||93%||10.56% / Yr|
|US Small Company Stocks|
(Fama/French US Small Cap Research Index)
|951||95%||97%||12.94% / Yr|
|Internat’l Large Company Stocks|
(MSCI EAFE Index)
|430||62%||83%||10.17% / Yr|
|Internat’l Small Company Stocks|
(Dimensional Internat’l Small Cap Index)
|1/1/1970 – |
|430||93%||98%||14.16% / Yr|
|Average of All Four||83%||93%||11.96% / Yr|
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?
|BONUS TIP: If all of this wasn’t enough to convince you, then consider that we live in usual times with the coronavirus pandemic. If you were to lose your job, then you’ll be glad that you went with the much lower payment 30 year mortgage!|
For more information on mortgages and other housing related topics, please check out our other articles.
CERTIFIED FINANCIAL PLANNER™