15 Year Fixed vs 30 Year Fixed Rate

The most fundamental question these days (i.e. post housing crunch) when applying for a mortgage is, “Should I take out a 15 year fixed rate loan, or fall back on the lower payments of a 30 year fixed rate loan?”

And that one simple question is fundamental to both your current and future financial well-being. The question of a 15 year fixed rate loan or a 30 year fixed rate loan should be one that you spend time answering for your situation. Don’t gloss over this one.

The Real Difference between a 15 year fixed and a 30 year fixed rate mortgage

As a rule of thumb, for the same closing costs and points, a 30 year fixed rate will be a 0.5% higher rate than a 15 year fixed rate loan. It does vary with (bond) market conditions. But that is a safe rule to base your decision on.

While the rate is lower for a 15 year mortgage, the monthly payment is higher, which stands to reason as the loan is being paid off in half the time.

How much higher? That is the unknown that scares a lot of mortgage borrowers. Truth is, a 15 year fixed rate mortgage is $210-240 per $100k loan amount higher than the corresponding 30 year fixed rate payments. The lower the mortgage interest rate, the higher the difference in payment. For example:

$100,000 loan amount:

15 Year @ 3.0%:     $691 per month              15 Year @ 6.0%     $844 per month

30 Year @ 3.5%:     $449 per month              30 Year @ 6.5%     $632 per month

Difference               $242                                                                  $212

Paying more every month, but for only half the number of months, has big savings over time. You will pay roughly 2.5 times the interest on a 30 year mortgage than you will on the corresponding 15 year mortgage. Based on the first set of numbers above, on $100,000 in principle the 30 year fixed borrower will pay $61,656 vs the 15 year fixed rate borrower who will pay $24,305.

At a glance, so long as you can afford the monthly payment without inhibiting cash flow, you should take out the 15 year fixed rate mortgage. The long-term savings is just too great.

And this is comparing the pre-tax savings. As you know, mortgage interest and property taxes are tax deductible. Rent is not. So, the after tax cost of the mortgage is important to quantify as well.

Based on the  numbers above, here is a chart of the real cost of that same mortgage, considering a 28% income tax bracket.

Opportunity Cost

Yet, advocates of the longer term mortgages will at this point throw a yellow flag and whistle “No! Take out a long term fixed mortgage and invest the difference. The opportunity cost is just too great not to take out the low monthly payment mortgage loan.”

This is the age-old debate between the ‘heady’ financial planners, exemplified by Ric Edelman, and the baseline experiential financial consultants, exemplified by Dave Ramsey. The former would say, in a nutshell, to take out a long-term mortgage and invest the difference. The latter would argue that it is more in tune with the human condition to focus on one thing, and pay off that debt asap. Then focus on the next.

Both would argue that their way reduces risk.

Let that sink in for a moment…both argue that their way reduces risk. Huh.

Well, again simplifying things greatly: the former would argue that saving the $225/month that the 30 year rate is NOT costing you, and seeing a return on that savings/investment, you have an insurance policy built in against calamities such as major medical expenses, job loss, etc, etc. While the latter would argue that investing carries risk in itself (i.e. stocks in 2008), and being debt-free removes all risk. The problem? Both are right, depending on who you are. So let’s look in broad strokes at who should choose either type of mortgage.

If you want to explore the long mortgage while investing the difference, you will really enjoy this 15 Year vs 30 Year mortgage calculator.

When to choose one over the other

Here is where it gets a little hairy. You see, I am a mortgage professional with a lot of years in the business – through housing booms and housing busts – and I have seen a lot of personal situations both really good, and the bad ones. I can offer advice based on that hyper-acceleration of experience on the topic.

But, I cannot (or will not ) pay that mortgage for you. So, no matter how sage the advice I can dish out, the ultimate decision for the loan that is right for you is, well, yours.

That said, let me give you some food for thought.

First time home buyer

You will hear that buying a home is cheaper today than renting. And with mortgage rates this low, that is generally true.

And yet.

If you have not owned a home in the past, then I recommend taking out a 30 year fixed rate mortgage for the purchase of your first home, in most cases. Because of reserves, maintenance and future options.

A lot of first time home buyers are young, and don’t have a lot of money in savings and investments yet. It is important to develop the habit of saving part of your monthly income as reserves, to build a liquid net worth, and just to have for the rainy day when that minor emergency hits. Because it will. So my advice would be to take out a longer term mortgage yet calculate the difference between a 30 year and 15 year mortgage payment. Discipline yourself to save the difference. Finances, like anything else, is a consequence of habits. And a habit can be good or bad. Take the first home purchase as a time to solidify good financial habits.

Owning a home is cheaper than renting a comparable home right now. Except when the water heater explodes.

The added cost of maintenance and repairs is real and you do have to save for them. That is the other reason for a longer term mortgage – even though it comes down to a similar reason, which is developing or solidifying the habit of adding monthly to savings because unexpected expenses do happen in life. This habit, early in home ownership life, will pay dividends in over time.

Finally, especially right now while homes are at an all time high in housing affordability, home buyers may want options that they have not thought through up to the present. And one of those options when the home buyer is ready to move up in home – or across town to the better school district when Junior appears on the scene – may be to hang onto that asset which is the home and convert that to a rental property. Cash flow could work out much better and even be the difference in allowing that option with a 30 year fixed rate mortgage on the home.

Headed toward retirement

The other end of the spectrum happens often times when the kids are grown and the next becomes empty again.

Retirement, while still a reality for many, is quickly becoming less cut and dried. But whether you will face a very official ‘retirement’ and fall back to a life of golf and grand kids or not, there will at least be a slowing down, and a mandatory pulling from your retirement accounts rather than so actively adding to them.

At that time, when you begin pulling from the savings, you want to balance out the outflow as well. You will want to pull for basic living expenses only – and at that point it will be time to have retired all critical debt. In other words, you will want to have paid off the mortgage in full, along with the car loans, credit cards, etc.

You will chose whether to carry debt on income-producing assets such as investment property. But the roof over your head is, at that point most especially, security, not an investment.

So, you will want to structure your home mortgage as a 15 year fixed rate at some point in your 50′s. That will ensure that, entering later years when you begin to pull from retirement accounts, that active, earned income has paid off all debt, and the accumulated funds pay only ongoing living expenses.

What is best for you?

I suppose that I would sum it up this way. If your principle focus in on accumulating wealth at this point in your life – to cover emergencies without breaking the bank or to be ready to one day slow down the active income in favor of living off of that accumulation – then the bias is toward a longer term, 30 year fixed rate.

On the other hand, if you can see on the horizon the time when you will begin drawing down your hard earned accumulated wealth, then the bias is toward a 15 year fixed rate loan. The goal will be to retire all debt by the time the active income slows.

And, if you opt for the opposite, then live it fully.

In other words, if you are a first time home buyer and opt for the 15 year fixed rate in order to retire all debt snowballs as soon as possible, then do so only while living fully the entire plan that such a decision entails. Have all other debt retired. Have your emergency fund. Put 20% down. And be maxing out your retirement savings. Short of that, don’t risk your financial future on a desire to follow a particular plan. Only actions count here.

And, if you follow the other camp of taking out a very long term mortgage and never paying it off, if possible, then also follow that plan to the letter. Actually do save the difference. And work closely with your financial adviser who both subscribes to and understands the risk or lack thereof that your investments must have.

I have seen the take out a long mortgage and invest the difference plan work very well. And I have seen the get out of debt as quickly as possible plan work very well.

And I have witnessed both approaches, lived partially, fail miserably to the heartache and duress of the people attempting them.

So the final word on this post is, you have to decide whether a 15 year fixed rate or a 30 year fixed rate mortgage is right for you. In deciding you need to be brutally honest about your own financial disciplines. And, if you are not prepared to follow either extreme financial plan to the letter, then take my advice. Start with a 30 year fixed rate and develop sound financial disciplines around that. Then migrate to a short term mortgage as retirement approaches.

And, as always, I enjoy helping readers of my blog with your mortgage. If I can help you, please call me at 1.800.MY.LOANS (1.800.695.6267).

Or, just click here to request a free mortgage quote.