I’m one of the rare examples of personal finance bloggers who thinks the 30 year mortgage beats the 15 year loan for most homeowners. Yes, there are advantages to paying off your mortgage in half as much time, but you still have to deal with the effects of a higher house payment for 15 years, and that’s a long time when life is out there happening.
Before getting started, let’s use the following numbers as a point of reference for comparison:
- A mortgage amount of $200,000 for both a 30- and 15-year loan.
- As of today, the going rate on a 30 year fixed rate mortgage is around 4.00%, with a monthly payment of $955.
- The 15 year fixed is currently at about 3.50%, giving a monthly payment $1,430.
- The difference between the payments on the two terms is $475 per month.
- Over the course of a full year, the difference between the two loans is $5,700.
Why is the 30 year loan better than the 15?
1. Better cash flow for other purposes
As you can see from the numbers presented above, if you had taken a 15 year mortgage, you’d have $475 less in your cash flow each month, or $5,700 each year. That’s money that will be effectively removed from your monthly and annual cash flow.
While paying off your mortgage in less time may be a worthy goal, it’s important to remember that there will be no tangible benefit to your cash flow until the mortgage is fully paid. With fixed rate loans, you don’t reduce your payment by paying down the loan – it will remain constant until the loan is gone. All of the benefit of the 15 year loan is on the back end, when the loan is paid! Until that happens, the most tangible financial affect will be a lower cash flow.
2. More options in an emergency
Let’s say you lose your job; right up there with looking for a new one as your new mission in life will be lowering your living expenses. Now we all know that short of selling your home, there’s no way to lower your mortgage payment when you’re unemployed. By the time you’ve lost your job, it will already be too late to do anything about your house payment.
A mortgage is long-term debt, and whatever terms you set up when you took it will be the ones you’ll have to deal with in the middle of a crisis. Though the standard financial advice is usually to do what will be the best thing in the long run, there may be no long run if immediate problems can’t be successfully dealt with.
This is just my personal thinking, but if you work in an occupation or industry that is prone to layoffs or is experiencing a contraction, you should stay with a 30 year loan. That of course is even more advisable if your compensation fluctuates. But increasingly this applies to nearly all occupations and industries – the ones that once were stable aren’t any more.
3. More control over your liquid assets
One of the overlooked issues of a 15 year loan is that it transfers cash into the home at the expense of other financial pursuits. Once money is paid into a mortgage, there are only two ways to get it out if needed: sell the home or borrow against it. Assuming that you have no intention of selling, borrowing will defeat the entire purpose of the 15 year loan.
But closer to home, there’s little point in paying off a mortgage in 15 years if you have credit card debt and car loans. Better to keep the mortgage outstanding longer and get rid of other debt, since mortgages are generally fixed rate and have tax advantages.
4. Broader investment diversification
The 30 year loan leaves you with more money for everything else. One of the problems inherent in a 15 year mortgage is that it means that a disproportionate amount of your household budget will flow into a single investment – your home. Financial advisors tell us to diversify as a way of protecting against declines in any investment class – since 2007 we’ve learned the hard way that house prices can go down as well as up.
That being the case, it makes sense to increase your non-housing investment. Because of its high cost relative to nearly everything else, most people are already “overweight” in their investment in their home to begin with. When it comes to a mortgage, you’re not just paying off a debt – every dollar of principal increases the investment in your home, and away from other investment classes.
5. You can still pay off a 30 mortgage in 15 years (or less)
This is what I like best about a 30 year loan, and the reason that it stands head and shoulders above the 15.
If you have a 30 year loan you can make payments based on what would be required to payoff the loan in 15 years. The advantage to this is that if you ever get into an emergency situation where you need to drastically cut living expenses, you’ll be able to fall back on the original payment – in our example above, that would be $475 per month less than the payment on the 15 year loan, or roughly the amount of a fairly large car payment.
Now accountants and financial analysts will make the point that in using this method you’re incurring a rate that’s .50 above the going rate for a 15 year loan, and they’re right. However, since mortgage interest is tax deductible, the higher rate paid for a 30 year loan will also create a bigger tax deduction. What this means is that the net interest rate you’ll pay for the 30 year loan will actually be something less than .50%, and maybe even a lot less when your marginal tax rates for both federal and state are added together.
But numbers aside, .50% – or what ever it will be net of the tax benefit – will be a small price to pay for the flexibility the 30 year loan affords, especially in an emergency situation.
What do you think? Are there compelling reasons why you think the 15 year loan is better?