15 vs 30 Yr. Loans: The Added Cost to Retire a 30-Year Loan in 15

When it comes to the great mortgage debate, I’ve already explained my position regarding 15- and 30-year loans: 30-year loans are better for a multitude of reasons. In fact, I think it’s a no-brainer.

I remember when I bought my first home in 1990, interest rates were in double-digit territory. Today, 30-year loans make more sense than ever with mortgage interest rates continuing to set new all-time lows. In fact, last week, a person with excellent credit could get a 30-year loan for rates as low as 3.375 percent and 15-year loans for an incredible 2.75 percent.

Enjoy it while you can, folks. Although it’s hard to believe, higher interest rates are inevitable.

One of the biggest advantages of the 30-year loan is its flexibility. After all, holders of 30-year loans can always make the extra payments required to pay them off in 15 years, should they choose to do so.

However, the poor guy with a 15-year note who suddenly gets laid off or runs into other unexpected financial difficulties, can’t reduce his payments in order to stretch that 15-year mortgage into a 30-year loan. Sure, he could try to refinance, but that can be difficult — especially for the unemployed.

Of course, the trade-off for having additional flexibility is higher interest payments.

Assuming a $200,000 loan, the impacts of those higher interest payments over time at today’s rates and can be seen in the following chart:

Obviously, folks with a 30-year mortgage are going to pay more interest, whether or not they make the extra payments required to retire their loan in roughly 15-years. Then again, how much more depends on how picky they are about getting the loan paid off in exactly 15 years.

In my example, a 30-year $200,000 mortgage at 3.375 percent results in a monthly payment of $884. Over 30 years, the home owner would end up paying $118,309 in interest to the lender — more than $70,000 compared to the 15-year loan at 2.750 percent.

However, for those who were truly serious about minimizing their interest costs by paying off that same 30-year loan in exactly 15 years, they could do so by increasing their monthly payments to $1424 (that’s $540 more than the minimum payment).

Over the life of the loan, that strategy would result in additional interest expenditures of only $10,491 compared to the 15-year mortgage. Spread out over 15 years, it’s a premium of just $58 per month. Not bad at all for those looking for the added peace of mind.

Alternatively, faithfully making monthly payments over the life of the loan equal to the 15-year mortgage at 2.75 percent ($1357) would result in slightly higher additional interest costs of $14,330. That’s a premium of $74 per month over the life of the loan, which would be a bit longer; in this case, 15 years 11 months.

So there you have it. Hopefully, this little example provides you with a bit more insight into just how much extra it currently costs to take on a 30-year loan over it’s 15-year cousin.

As you can see, no matter how you slice it, people who prefer the numerous advantages of a 30-year loan over a 15-year mortgage are always going to pay more interest.

But for those who are looking for the extra flexibility of a 30-year loan as a hedge against a sudden loss of income or the prospect of high inflation, the added premium is a relative bargain.

Photo Credit: James Thompson

Comments

  1. 1

    says

    If you can pay it in 15 years then why not? It leads to peace of mind to have it taken care of faster and then all you’ve have to worry about is insurance and taxes!

  2. 2

    Chuck says

    We recently decided to go with a 30 year loan instead of the 15 too. We’re making extra payments in order to pay it down in 15 years. I made the same analysis you did when comparing mortgages and came to the same conclusion. The added cost is definitely worth the flexibility we get with our 30 year loan.

  3. 3

    says

    I agree 100%. Get a 30-year mortgage, than make payments with the aim of fully retiring it in 15 years. I think of the very small interest rate increment between 30 and 15-year mortgages as insurance against unexpected financial challenges. If I’m laid off or my finances change such that I can’t pay the extra, I can always revert to the 30-year required payment and stay in my bank’s good graces.

    • 4

      Len Penzo says

      Yep. In my case, I’m still making extra principle payments, but now those payments are invested in a separate account that is earning interest. At any time I can use that money to pay down my loan — or pay it off all together once the money in the account reaches my mortgage payoff balance. That allows me to take maximum advantage of my tax deductions. But best of all those extra payments are fully liquid, as opposed to being tied up in equity — as they would be if I was giving it to my lender as extra principal.

      • 5

        Ted says

        In other words, it seems like you are saving up cash to preclose the loan when possible. The existing 30 year (I assume) loan provides you the tax benefits while it is still on.

        Am I missing a point here?

        PS: Like the blog. Would love to see more articles on basic investing (not just US related), money management, and real-life-stories.

        • 6

          Len Penzo says

          You nailed it, Ted.

          And thanks for the feedback. I don’t do a lot of investing articles because it’s not an area I feel comfortable handing out advice; there are many people a lot more competent in that arena than me, Ted.

          I have a lot of real-life stories buried in the archives. You’re right, I need to write a few more money management pieces. It’s been awhile since I’ve done one.

  4. 7

    Laura W says

    Well, I’m going to be the contrarian here. DH & I just refinanced our 30 yr to a 15 yr mortgage, to take advantage of lower interest rates. In the end, we are paying almost the same monthly amount with the 15 yr that we were paying with the 30 yr mortgage, and we still have the capability of making additional payments. If all goes well, we could potentially have the mortgage paid off in 11 yrs. Better than the 23 yrs we still owed!

    • 8

      Len Penzo says

      Good for you, Laura! You can never go wrong paying off your mortgage early.

      I made the exact same move you did the second time I refinanced my current home. I went from a 30 year to a shorter loan with a cheaper interest rate in order to accelerate our loan payoff date without increasing my monthly payment.

      But then the economy went south and the US money printing presses went into overdrive. So I changed my long term financial strategy with respect to paying off my mortgage early.

  5. 9

    says

    I agree with the concept, but very few people have the discipline to accelerate a 30 year loan. When I refinanced close to 10 years ago, I went with a 15 year loan. A couple years ago, I started to accelerate paying off the loan to coincide with retirement.

    • 10

      Len Penzo says

      I agree, Larry. People who don’t have the discipline but really want to pay off their loan as fast as possible would probably be better served with the 15, assuming they have a lot of job security.

  6. 11

    Sheila says

    I can’t remember ever using the phrase ‘only $10,000 more’ in reference to anything that I am personally doing. :) It won’t surprise you to know I’m pretty firmly in the 15 year camp. FEW people actually pay additional payments every month. We have a 15 year and do pay additional every month, but it’s because I automated it from the beginning of the loan and don’t ‘decide’ every month to do it. It’s like making the decision to go or not go to the gym when the alarm goes off at 4:30 in the morning. Who’s going to decide to go then? You have to decide you are going the night before. That’s probably a silly example, because who sets their alarm for 4:30 am if they aren’t going to the gym? This is why I don’t blog myself. :) I enjoy reading yours even when I don’t totally agree.

    • 12

      Len Penzo says

      I can’t remember ever using the phrase ‘only $10,000 more’ in reference to anything that I am personally doing.

      I know; that does sound kind of kooky, huh? lol

      Anyway, Sheila, we don’t have to always agree; it’s called personal finance for a reason, after all, and sometimes what’s right for one person might not make sense for someone else. This is definitely one of those times! :-)

  7. 13

    says

    I mostly agree. :-) When we bought our current home in 2007, the difference between the 15 and 30 year interest rate was a full 1%. But the difference between the payments was $740 instead of $530. For the $200 a month difference, we just went to the 15 year rate. It ended up not mattering much, since we have now refinanced to another 15 years and our monthly payment is now $505 since we overpay as a rule.

    BUT, we are buying our new home with a 30 year mortgage since the monthly payment difference is REALLY significant and we do want the flexibility to pay the minimum if necessary. :-)

    • 14

      Len Penzo says

      I know I sleep a lot easier at night knowing I’ve got a mortgage payment that I will be able to cover even if I get laid off.

  8. 15

    David M says

    I agree with the “contrarians” that stated most people do not have the discipline to make the additional payments – thus – if you can easily afford the 15 year loan – I absolutely think that is the way to go.

    I started with a 15 year loan and 2 years into the payback – I refinanced to a 10 year loan.

    I have made a lot of extra payments and 4 years after buying my home – I have paid off 50% of the original principle.

    David M

  9. 17

    says

    I am sure my husband would appreciate your argument and agree with it. Being an emotional woman I just want my mortgage paid off – a woman can dream, you know, and sometimes her dreams may come true.

    • 18

      Len Penzo says

      There is nothing wrong with wanting the peace of mind that comes with owning your home free and clear, Maria.

      In my case, I happen to be an engineer. And engineers and emotion go together like oil and water. ;-)

  10. 19

    says

    Personally, I prefer 0% interest. We paid off our mortgage earlier this year.

    What’s annoying though is we still get calls from time to time soliciting “refinance your mortgage at a lower rate!”. This is in spite of being on the do-not-call list.

    If I’m feeling amused, I might say, “Really? You can refinance at less than 0%? You would pay me to borrow money?” That usually leaves ‘em confused.

  11. 20

    says

    I disagree with your characterization of the added cost of $58/month or $74/month as a small price to pay for flexibility. You are basically buying payment flexibility insurance, which lets you drop your monthly payments down by ~$500 just in case you need the cash flow. As such, it should be compared to the cost and benefits of other insurance, like auto or homeowner’s insurance. At $58/month or $74/month it’s basically doubling your auto insurance or doubling your homeowner’s insurance (depending on your area and circumstances of course). Compared to possibly causing injuries and damages of $100k or more covered by your auto insurance, the payment flexibility insurance pays so little. It doesn’t even pay your $500/month. You still have to pay that $500/month eventually, with interest. So not worth it.

    • 21

      Len Penzo says

      I categorically — but respectfully — disagree with your assertion, TFB. Comparing long-term loan payments to one-year auto insurance or homeowners insurance premiums is apples and oranges.

      The flexibility isn’t just regarding extra cash flow, it’s also about the declining value of the dollar over long periods of time. Or short periods of time in high inflation. Don’t ignore the opportunities that can arise from those higher rates and the effects of the time value of money, which make the real value of those payments much less in real dollar terms as the currency loses its purchasing power.

      This basically comes down to whether you think interest rates will remain at record lows for the next 15 or 30 years — or not.

      In my case, I am absolutely certain interest rates will not be this low 10, 20, or 30 years from now. They will be higher — and almost certainly much higher.

      Why lock myself in to paying 3 percent interest to the bank if I will be able to earn 6 percent in a savings account? Those days will be here again, mark my words. When I was a kid, I remember my savings earning 16 percent interest.

      Simply put, I’m not going to lock myself in to paying the bank 3 percent when I can use the extra payments to earn more than that down the road.

      This strategy would not work if interest rates were already high — but they’re not. They’re probably as low as they’ll ever be!

  12. 22

    says

    I’m in a 15, only because I hope to be retired in 10 years or less. If I were in my 30s, the 30 year would be a no-brainer. I’d rather have a $200,000 mortgage and $200,000 in the bank. Because when you lose your job, no bank is offering you anything. At the current sub-4% rates, after taxes and inflation, it’s free money.

  13. 24

    Greg says

    Your negative doomsday logic is so far into left field. Usually you only get this kind of stupid drivel coming from professors that have never accomplished anything in life. 1. Save and pay cash for the house and then you never worry about making the payments. 2. If you can’t wait that long then save at least 20-30% and buy a house that is priced correctly (good value and not more than you can afford) and do a 15 year mortgage then focus on paying it off ASAP (less than 5 years). I guarantee you sleep much better with no house payment than with an inexpensive 30 year payment. Besides most people that take a 30 year mortgage just purchase a bigger house so the payment is the same as if they had bought what they should have on a 15 year.

    • 25

      Len Penzo says

      There are other reasons besides peace of mind, Greg. For example, what about the advantages of having a long term loan if interest rates rise? The declining value of the dollar over long periods of time will make my $600 mortgage even easier to handle as inflation begins chip away at the buck’s store of value.

      And your assertion that most people take a 30 year mortgage to purchase a bigger home is a strawman argument.

  14. 26

    Tom says

    Really, you gotta be kiding me. Is that the best you have;flexibility? Get real. A 15 year note forces the borrower to make the payments instead of saying “well I will pay more when I can etc. Sorry, but I own 5 houses, mostly rentals all with 15 yr mortgages. It is the best way to go and forces you to think ahead and make the payments when they are due. If you want to be 20 years into a 30 yr mortgage and still owe 73% of the loan principal, go for it. You will never really get ahead in life and the banks love you.

    • 27

      Len Penzo says

      On the contrary, Tom, the banks will HATE me. And I have a lot more reasons than flexibility. See this link:

      http://lenpenzo.com/blog/id1626-the-15-year-vs-30-year-mortgage-debate-why-30-is-better.html

      As interest rates begin to rise — as they surely will — the dollar’s value will begin to erode even more than it already does. The banks will hate that I am paying them back with dollars that are worth much less over 30 years than their customers who insist on paying them back with dollars that are more valuable. Remember, inflation is a friend to debtors — not savers.

  15. 28

    Rose says

    Thank you Mr. Penzo. For me personally, I just want to say “thank you” for taking the time to keep us informed. I for one value your opinion and also enjoy the opportunity of hearing what others have to say. A friend of lenPenzo.com until the end…. Thank you!!

  16. 31

    Dan says

    There is such a thing as good debt and a 30 year mortgage fixed in the low 3%’s is a good debt to have for so many reasons. How about investing the difference between the 15 year and the 30 year monthly payment into a Roth IRA? Select low cost, globally diversified index funds and invest automatically each month.

    • 32

      Guy says

      Now this I can agree with. If you are able to invest it into the stock market and get even just a 5% return you will be better off than paying off your mortgage. Additionally stocks and mutual funds lead inflation so you won’t have to worry about losing money to inflation. And best of all you can liquidate it if you ever actually need it for something! You make money, low payments, and have access to your money all at the same time.

  17. 33

    Guy says

    Hmm, interesting take. But I disagree… The last one seems terrible, you end up paying almost 3 times as much in interest. I’d find it hard to believe that inflation can make it anywhere close to being worthwhile. The second one you end up paying more a month (less you can save) and still pay more in interest overall over the same time period. Not that great either.

    So lets go with the third option. It costs 14k more in interest over its life but you get the ability to drop to 800 dollars a month in case of an emergency. But at 14k I’d be able to take out a loan for a couple years and use that to drop my payments to 800 dollars a month (and use it to pay itself back) and the cost in interest will be way less than 14k (assuming I actually get a job again in the next few years so I can pay back the new loan before that extra cash runs out).

    Some Numbers:
    Let’s say I take out a 20,000$ loan when I lose my job at 5% interest over 3 years. The monthly payments for that loan are around 600$. I also use 473$ to pay the difference that you would drop to paying. So we both will end up paying the same amount in mortgage out of our savings. At 20,000/1,073 (the loan/the cost of paying the loan and the padding in mortgage) it gives me about 18 months to get a job to start paying back these loans. The interest I pay on that loan will only be about 2k. I save 12k AND get to still drop to 800$ in case of a lost job/emergency.

    Even at 8% over 4 years you end up paying around 4k which is much less in interest than you would if you pay with the 30 year rate. Really doubt inflation can make it even close.

  18. 34

    Lizza says

    After selling a business and the price of homes sky rocketing. I paid cash for my house in 2004. As of today my house is is worth less than half of what I purchased it for (California)Yes I am debt free, but I highly doubt my home will ever be the price I paid. I’ll be here the rest of my life not because I want to be but because I have no choice. If I had rented I would have been 1/4 of a million dollars richer.

  19. 36

    jim says

    Spouse and I debated about this for a couple of years and then just went with a 15 year fixed mortgage – a sort of “forced savings” – but only because we had a good ER fund in the event something went south. Since we started doing this, we liked watching the principle fall so we added another $2500/mo (to a $1300 15 year mortgage). This baby is going to be paid in full in 3 years – just to coincide with the time our youngest is finished with law school. Guess what? Our standard of living has not decreased one iota (other than our traveling) and we’re not even missing this right now since we’ve got grandbabies to play with. This house is going to be paid for in full long before we retire and those otherwise mortgage payments are going right into our retirement/traveling funds. Take the 15 year fixed EVERY time!

  20. 37

    Bill in NC says

    Ultimately the best way to think of a 30 year loan is as a long-term rental contract.

    With the possibility (no longer the certainty) of appreciation (historically, however, only about 1% over inflation).

    As another poster points out, even 20 years into a 30 year mortgage there’s been very little principal repayment, so likely little equity in the home.

  21. 38

    Jason says

    Good post… it’s interesting to see how the numbers work out. One error to be careful of, though, is to look at the Total Interest column as if all those dollars have the same value. That’s not the case, especially with the 30-year payoff.

    I would resolve that by running a Present Value of Cash Flows calculation for each scenario. This way we can see the real difference between these options in today’s dollars.

    I ran ballpark numbers using this calculator: http://www.calculatorsoup.com/calculators/financial/present-value-cash-flows-calculator.php

    Interest (Inflation): 3%
    Compounding: 12 per period
    Cash Flows: At End
    Lines: 1
    Periods: # of Years below
    Cash Flows: Yearly payment below

    15 Yrs @ 1357/mo or 16284/yr = PV $193,814
    15 Yrs @ 1424/mo or 17088/yr = PV $203,383
    16 Yrs @ 1357/mo or 16284/yr = PV $203,896
    30 Yrs @ 884/mo or 10608/yr = PV $206,808

    This makes it clear that the big gain in value is between #1 and #2, not between #3 and #4 as the Total Interest would lead you to believe.

    What does that mean? There’s little value gained in paying off a 30-year mortgage early, even 15 years early. If you seriously plan to pay off your home in 15 years, then it’s worth it to seriously consider a 15-year mortgage.

    Of course, this isn’t taking the soft factors into account, but it does make it more clear what they’re worth:

    The flexibility of a 30-year mortgage with lower monthly payments actually costs $12,994 in today’s dollars.

    Likewise, the 15-year mortgage is $12,994 cheaper than the 30-year.

    And the relief of paying off a 30-year mortgage in half the time yields roughly $3,000 in savings.

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