The 15-year vs. 30-year mortgage debate
A 15-year mortgage allows you to pay off your mortgage twice as fast while saving a significant chunk of money on interest. Now let's examine some other issues.
According to Freddie Mac's survey last week, there was a spread of 0.79 of a percentage point between the 15- and 30-year fixed-rate mortgage benchmarks, which just so happened to be the largest spread since Freddie started tracking the 15-year mortgage 20 years ago. For comparison purposes, the average spread over that same time period has been only 0.47.
I think most people naturally assume that, when it comes to choosing between a 15- or 30-year fixed-rate mortgage, the 15-year loan is usually the better option anyway. Throw in this historic spread, and I'm sure a lot of folks out there are now beginning to think they'd be absolutely crazy to take out a 30-year loan. Post continues after video.
On the surface, it makes sense. All things being equal, a 15-year mortgage allows you to pay off your mortgage twice as fast while saving a significant chunk of money on interest.
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That being said, I still think the 30-year mortgage is a more logical choice for most people because it has so many more advantages over its shorter-termed cousin.
Here are several big reasons why I think a 30-year fixed-rate mortgage is the more pragmatic choice:
- Lower payments. Of course, the biggest advantage of the 30-year mortgage is that it comes with lower payments, and the difference can be used to invest or save as you see fit. In fact, it doesn't take a rocket scientist to know that 30-year mortgages are much ...
- More budget friendly. Those lower payments not only take the strain off tight budgets but, if need be, they also allow you to stretch your dollar enough to purchase a more expensive home.
- Increased flexibility. Two years ago, with my employer in a bit of trouble and potential layoffs looming, I refinanced from a 15-year to a 30-year mortgage in order to lower my monthly payments by more than 40%. Today, with the layoffs still going on, you can bet I sleep a lot better knowing that my mortgage payment is only $600 per month instead of $1,000.
- More control. With a 30-year mortgage you are almost always free to make additional principal payments necessary to pay off your loan in 15 years without penalty. However, you are never obligated to do so, and can always change your mind as life's circumstances dictate. With the 15-year loan, you are hopelessly committed to giving that extra money to your lender each month -- whether you can really afford to at the time or not. This leads to another big advantage of 30-year loans.
- Reduced financial vulnerability. By committing to give your lender that additional principal each month, you could be needlessly tying up too much of your money in your house. While it's true that the shorter loan builds home equity faster, you still need a lender's permission to tap into it with a home equity loan. If I lost my job tomorrow, it is highly unlikely my bank would agree to give me such a loan, making that equity useless to me in time of need.
- More opportunity for financial balance. Yes, building home equity and getting that house paid off is a noble goal. However, for young people just starting out, there are often other very important financial obligations that need to be addressed too. The higher payments that come with a 15-year mortgage make little sense if that leaves you unable to build an emergency savings account, or contribute anything to your 401k plan, IRA, and perhaps your kids' college funds.
- Bigger tax deductions. I can hear all those keyboards banging out the nasty emails to me right now. Len, you dummy, agreeing to pay more interest in exchange for a bigger tax deduction is like spending a dollar to save a dime.I get it. This should never be the only reason for taking a 30-year mortgage over a 15-year mortgage. However, all things being equal, the larger tax deduction for the 30-year loan does temper the interest savings of a 15-year loan -- if only a little bit.
- Effective inflation hedge.Inflation erodes the value of the dollar over time. As a result, payments made during the last 15 years of a 30-year loan are significantly lower in real terms than the day you first got the loan. That's why banks hate sustained periods of high inflation: Folks with longer-term fixed-rate loans end up repaying those loans with dollars that are worth far less than the value of the dollars they originally borrowed.
No matter how you look at it, the faster inflation rises, the less sense it makes to pay off the mortgage early. With that in mind, a 30-year loan is definitely your best opportunity to stick it to the bank. For many people, I suspect that's probably reason enough to choose one.
More from Len Penzo dot Com and MSN Money:
A $150,000 loan @ 4.1 % @ 15 years = $1117 per month = $201, 060 total
Stick it to the bank you say on a 30 year loan................uh........................ok
The 15 is so much better especially if you work hard and make extra payments. We started with a 30 loan, refi'd with a 15 year, and were able to payoff just shy of 11 years.
Needless to say we saved a mountain of cash and will reap a nice reward when we sell off in about 10 years or become slumlords.
The interest write off is a pebble in a pond that is highly exaggerated and your lovely congress is trying to kill it off completely.
Your goal should always be to never give a banker a penny more in interest than you need to.
Work to pay off your big ticket items, cars and house and you will save large and not have to work so hard for no good reason...............paying a banker is no good reason.
Additionally, the average time in a house is 7 years. So with a 30 year note you will really struggle to ever pay off a mortgage as after 7 years only 12% has been payed off compared to 37% with a 15 yr note (thats calculating 5% loan for both). You are almost completely dependent on price appreciation and then discipline on the next purchase in order to get ahead; the first has historically not been a big problem but is completely out of any one persons control while the latter is very controllable and yet is sadly lacking in many Americans.
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