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. But does it make financial sense to pay that 30-year loan off faster when the Fed is rapidly debasing the dollar with its insane quantitative easing (QE) program?
As you’re about to see, the evidence suggests that it’s not.
More Flexibility Means Less Risk
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.
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 at or near all-time lows; as of June 2020, a home buyer with good credit could easily find a 30-year loan for 3.375% and 15-year loans for an incredible 2.75%.
Assuming a $200,000 loan — and a very conservative annual inflation rate of 3% — 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% results in a monthly payment of $884; and if you wanted to pay off that same 30-year loan in exactly 15 years, you could do so by increasing the monthly payments to $1424. (That’s $540 more than the minimum payment.)
In nominal terms, a homeowner will pay $118,309 in interest to the lender — that’s more than $70,000 compared to the 15-year loan at 2.750%! Alternatively, faithfully making monthly payments over the life of the loan equal to the 15-year mortgage at 2.75% ($1357) results in far-lower additional nominal interest costs of $14,330. However …
When one considers the declining value of those dollars over time (as shown in the Present Value column), the analysis is quite different because the resulting financial impacts aren’t as pronounced. In fact, the 15-year mortgage is actually “just” $12,994 cheaper in today’s dollars than the 30-year loan. So those who desire the flexibility of a 30-year mortgage with lower monthly payments still pay a premium for that convenience — but it’s just $36 per month in today’s dollars. Not bad.
One last observation: For this example, paying off a 30-year mortgage early probably isn’t worth the effort. As the Present Value column indicates, even if the 30-year loan is retired in half the time, the real savings amount to little more than $3000.
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 its 15-year cousin.
Yes, 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 — and if the Fed’s QE program continues to debauch the currency even more in the future, those resultant savings in real terms would be even greater.
Photo Credit: James Thompson
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!
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.
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.
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.
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.
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!
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.
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.
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. 🙂
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.
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
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.
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.
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.
I disagree with your characterization of the added costs 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. Compared to possibly causing injuries and damages of $100k or more covered by your auto insurance, the payment flexibility insurance pays so little. Not worth it.
I disagree, TFB. Comparing long-term loan payments to one-year auto insurance or homeowners insurance premiums is apples and oranges.
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.
We went a step further and paid off our 30 years fix mortgage within 5+ years! It is a great felling that you OWN the house not the bank. 😀
As long as there are property taxes, even people who pay off their mortgage are still stuck paying “rent” to the government.
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.
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 — or the dollar collapses in value? 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 the assertion that most people take a 30 year mortgage to purchase a bigger home is a strawman argument.
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.
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
You talk as if nobody is ever at risk of losing a job — for any reason, including poor health.
It’s also about time value of money, which you seem to completely dismiss. 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 and those who pay their loans off early.
I can see Tom, who supposedly is the smartest guy in the room, has no concept of real vs nominal terms. Why is it the most arrogant people have no idea that they’re also the most clueless.
smh
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!!
Thank so much for the nice words, Rose! I appreciate it. 😀
Absolutely! Anytime, keep posting and I’ll keep reading! 😀
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.
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.
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.
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.
Agree that people with 30 year loans can make extra payments, but realistically, very few people will do so.
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!
I refinanced to a 30 year after suffering a set back a few years ago. I am one of those paying extra every month to have things paid off in about 11 years. I cannot stress the importance of being able to immediately cut ANY and Every required outlay when things get tough. Sound advice to put the extra aside/etf as available immediate cash during this interesting time. The time to have cash, is when you don’t need it available. Life can change so quickly. Always appreciate your posts.
Thank you!
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.
I love this one Len! We just applied a home loan and we decided to choose a 30 year loan, it is very flexible because we can also pay an extra amount every month.
Interesting! I’ve always wondered why many people recommend stretching the loan to the longest term possible and you have explained it very well. Thanks!
I own rental properties and as long as I still have credit to buy additional homes I will always let the mortgage run its full term. This allows me to save the additional cash flow to use for other investments and allows me to pay the mrotgage with the rent payments. I use the same approach for my personal residence. I would prefer to have money in hand. I do feel that this will change as i get closer to my retirement. I understand the opinions from both sides but this decision is one the is determined completely by your investment/retirement strategy. Thanks!
I’m with you, JB. I prefer money-in-hand too.
We chose a 30 year mortgage for precisely your reason of flexibility, which came in really handy during those months of unemployment. During other months, we paid a great deal extra, though, and ended up paying off our mortgage in a little over six years. I tell ya, I miss those payments like a mind-blowing headache!
I would say it all depends on your age, when your going to retire and how long your planning on staying in the house. 15 year mortgages sound right, but in my line of work you might have to up and move to follow your job and that could be bad move!
I never had a mortgage, but I did take a car loan for 4 years. Instead of 5 or 8 years, I chose 4, even if it was pretty difficult to pay like this. I also lost my job one year into the contract, but it put a fire under my butt and managed to get my business up and running, so that I don’t lose the car and all payments. It’s difficult to choose a faster payment rate, but I’d do it with a mortgage, too. Sure, it does make sense to choose 30 years and be more relaxed, but I’d probably get the 15 years and try to pay it as fast as possible.
Thanks for sharing that, dojo. At low interest rates, the cost of flexibility is relatively cheap. Of course, as interest rates rise, the flexibility costs get more expensive too. There is a point for everyone (including me) where the opportunity cost of having that flexibility is too great, thereby driving them to a shorter loan period.
I paid my loan in just 18 years. And I was very satisfied with it. I just wish I could have done it earlier for less stress and for me to focus on other things like increasing my contribution to 401(k). If you can do it, why not? The earlier the better.
Hey Len,
I discovered your blog through Stacking Benjamins. I discovered the power of inflation on mortgages last year and posted a video blog on it.
https://www.youtube.com/watch?v=DJpt-eysT8o
Long story short, I went through the exercise of showing how inflation works in my favor on a 30 year. I think this whole thing is a lesson in opportunity cost. Even if you don’t play the arbitrage game, you are ultimately sacrificing the most expensive “present value” money by paying off your mortgage that could have otherwise been used to make cheaper present value purchases. In my case that trying to figure out if I buy a car, fix my deck or pay more to the mortgage. The price off goods goes up every year at a relatively predictable rate, usually keeping pace with inflation. Income however, doesn’t always follow suit. So inflation can work against you – it always works against you. But a long mortgage is the ultimate inflation hedge provided that your interest rate is low.
I linked to the oster miller mortgage calculator on my video, I’d encourage anyone run the numbers themselves on their own mortgage and then contemplate the dollar value that inflation carves out on the length of 30 years. There is a lot of opportunity LOST by not taking advantage of that inflation hit at the 30 year rate. And by paying early, the money is equity at that point – value locked into a house that can only be tapped by another mortgage or LOC.
Great comments, Stacy! You’ve got a great handle on the benefits of not paying down a low-interest long-term mortgage.
Most people usually fail to take into account the time value of money. I hope you become a regular here!
It works very well for me!
I really want to thank you Len. I remember about 5 years or so I was trying to figure out whether to upgrade our house. We lived in this adorable spanish colonial and had a 15 year fixed super low 2.8 or something percent mortgage. We could have paid the house off quickly. Then I read one of your mortage post about 15 versus 30 year fixed. And I knew we needed a bigger house due to the kids and we weren’t going to early retire in our 30s because that would be just silly for doctors. And I sat and went through the calculations about 15 versus 30 year fixed, our old house with standard house appreciation values, calculated tax deductions, and the cost it would be to move into a large rebuild my brother was doing near the coast. And it was crazy, when I crunched through the numbers the larger house with the 30 year fixed with our deductions and the house appreciation because leveraging a slightly bigger mortgage – actually cost us the same or it just made more sense rather than spending 100K on a remodel of our smaller house and we would do better financially. So we moved to the bigger house with the 30 year fixed partly because of your post made me think years ago. You increased my net work now 400K because that it how much our house has appreciated and it was right before the new tax laws came reducing the home mortgage deductions to less than a million. So anyway, you helped me get 400K richer and I locked in the home mortgage deduction and my kids have their own bathroom each and I live near the beach and now I pick up trash there. So really you helped birth Dr Plastic Picker!!! So thanks Len! Its always a treat to read your posts!
Wow … that is awesome! Thank YOU, Dr. P!
With yields so low on cash it likely makes sense to start making extra payments right now. If deflation takes hold then paying off the mortgage would be a no brainer.