Throughout the years, the vast majority of people I’ve worked with really want to pay off their mortgage in 15 years. Despite the deep down temptation to be pay off your mortgage early, I only see 2 reasons why you should ever go with a 15 year mortgage in today’s environment.
Fear and Comfort
It’s understandable why you wish to be mortgage free sooner rather than later. For starters, you don’t want to have a huge mortgage expense in retirement. And second, you don’t want to pay more in interest than you have to.
In other words, you have a fear of carrying a mortgage too long and you are comforted by your efforts to eliminate it fast.
These arguments certainly make sense from a financial and emotional standpoint, but as you’ll soon see, the 30 year mortgage is usually far better.
Reason #1: Your Retirement Plan Supports It
Despite my best efforts to convince clients of the superiority of the 30 year mortgage, the emotional pull for them to be debt free is screaming much louder at them.
In those circumstances, we only give them our blessing if their retirement plan supports it. You see, your goals should control all your decisions. If choosing a 15 year mortgage would jeopardize your retirement goal, then you shouldn’t go with the 15 year mortgage. Period!
However, if your plan works regardless of the mortgage length, then it’s perfectly acceptable to go with the 15 year option. But even in that situation the 30 year mortgage oftentimes superior.
The Evidence
Now, let’s look at some evidence.
As mentioned earlier, one of the major reasons people choose a 15 year mortgage is to reduce the amount of interest they pay. The effect of this is that you also build up equity at a much faster pace.
But are these valid reasons to choose a 15 year loan? No, and here’s why.
Assume you have a $300,000 mortgage. The 15 year interest rate is 2.75% and the 30 year interest rate is 3.25%.
The 30 year mortgage allows you to have a much lower payment ($1,306 / mo) than the 15 year mortgage ($2,036 / mo). And the difference between the two payments ($730 / mo) can be invested. It’s this investment piece that allows you to potentially make much more than you would have paid in interest.
In the chart below, we are looking at the first 15 years of the loan. If you chose the 30 year loan and you invested $730 / mo for 15 years, you would end up with $213,000 (assuming a 6.00% per year growth rate) which is far more than the $66,000 in interest you would have paid on a 15 year loan. And even though your equity is far lower, you still come out ahead with $27,000 more in your pocket by going with a 30 year loan.
This is great news because it means that even if you wanted to pay off your loan in 15 years, you would have more than enough money to do so. In fact, you’d have $27,000 left over.
So, if you absolutely must pay off your loan in 15 years, then get a 30 year mortgage, and use the investment proceeds.
15 Year vs 30 Year Mortgage (at end of 15 years)
| 15 Year Mortgage | 30 Year Mortgage | |
|---|---|---|
| Interest Paid | $66,000 | $121,000 |
| Equity | $400,000 | $214,000 |
| Savings | $0 | $213,000 |
| TOTAL Equity + Savings | $400,000 | $427,000 |
But wait, it gets better.
If we play out the results over the full 30 year period, then your net worth is much larger as a result of having a 30 year loan.
This happens because you are able to invest $730 / mo for a full 30 years with the 30 year loan. Remember that you’re able to invest this amount of money since your payment is much lower than the 15 year loan.
The 15 year loan, on the other hand, only allows you to begin investing once the loan is paid off. At that point, you can begin investing $2,036 / mo from years 16 to 30.
What’s interesting is that even though you are investing more money with the 15 year loan ($2,036 / mo x 15 years = $366,000) compared to the 30 year loan ($730 / mo x 30 years = $263,000), you end up with far more savings with the 30 year loan.
In the chart below, you will notice that you accumulate $737,000 in savings with a 30 year loan compared to only $595,000 with the 15 year loan. That’s a whopping difference of $142,000 in favor of going with a 30 year loan.
So, even though you paid over $100,000 more in interest with the 30 year mortgage, you still come out $142,000 ahead! And imagine if you actually earned more than 6.00 % / yr on your investment. At just a 1.00% increase to 7.00% / yr, the 30 year mortgage benefit increases from $142,000 to $247,000. This is why the 30 year mortgage is usually superior to the 15 year mortgage. It is a way for you to build wealth.
Dave Ramsey would convince you otherwise that you should NEVER get a 30 year mortgage. But I wholeheartedly disagree with this. But of course I encourage you to form your own opinion.
15 Year vs 30 Year Mortgage (at end of 30 years)
| 15 Year Mortgage | 30 Year Mortgage | |
|---|---|---|
| Interest Paid | $66,000 | $170,000 |
| Equity | $400,000 | $400,000 |
| Savings | $595,000 | $737,000 |
| TOTAL Equity + Savings | $995,000 | $1,137,000 |
Reason #2: Your Investment Won’t Return at Least 4.38% / Yr
Earlier I said that the savings provided by the 30 year loan allows you to “potentially” make much more money than the interest you would pay on a 15 year loan. In my examples above, I assumed you would earn 6.00% / year, but what if that doesn’t happen?
For sake of argument, let’s assume that your money is invested in the stock market. In the chart below, I am comparing the performance of 4 different segments of the stock market (US Large Company Stocks, US Small Company Stocks, International Large Company Stocks, and International Small Company Stocks).
If we assume that your money is equally invested in all 4 segments, then 83% of the time, your return was greater than or equal to 6.00% / year historically. But of course this means that 17% of the time your return was less than this. Nonetheless, the odds are significantly in your favor to earn at least 6.00% / year making the 30 year mortgage very attractive.
Perhaps you’re wondering what the minimum return would have to be on your investment in order for the 30 year loan to provide the same net worth as the 15 year loan. Let’s call this the breakeven return.
The best way to evaluate this is over a 15 year period as you may not be in a position to invest for the full 30 years. In order to breakeven with the 30 year mortgage, you would need your investment to return at least 4.38% / year for 15 years. And as the chart shows below your investment would have earned 4.38% / year or greater 93% of the time historically assuming you are equally invested in all four stock market segments.
So, if you don’t feel like your investment will return at least 4.38% / year over a 15 year period, then by all means go with a 15 year mortgage. However, if you feel you can earn more than 4.38% / year, then you’ll find that you’re able to build significant wealth with a 30 year mortgage (especially if you earn the 11.96% / year average return of all 4 stock market segments).
| Stock Index | Years | # of 15 Yr Periods | % of Time Return >= 6.00% / Yr | % of Time Return >= 4.38% / Yr | Avg Return |
|---|---|---|---|---|---|
| US Large Company Stocks (S&P 500 Index) | 1/1/1926 – 9/30/2020 | 958 | 83% | 93% | 10.56% / Yr |
| US Small Company Stocks (Fama/French US Small Cap Research Index) | 7/1/1926 – 8/31/2020 | 951 | 95% | 97% | 12.94% / Yr |
| Internat’l Large Company Stocks (MSCI EAFE Index) | 1/1/1970 – 9/30/2020 | 430 | 62% | 83% | 10.17% / Yr |
| Internat’l Small Company Stocks (Dimensional Internat’l Small Cap Index) | 1/1/1970 – 9/30/2020 | 430 | 93% | 98% | 14.16% / Yr |
| Average of All Four | 83% | 93% | 11.96% / Yr |
Summary
In summary, there are only 2 reasons why you should go with a 15 year mortgage in today’s interest rate environment – if your retirement supports it and if you don’t think you’ll earn at least 4.38% / year on your investment.
We are currently in a very low interest rate environment in our country and this is why the 30 year mortgage works so great and why the breakeven rate of return is so low. When mortgage rates rise, so will the breakeven rate. This is why it’s so important to go with a 30 year mortgage today. We may not always have rates this low. And you may not always have this opportunity to potentially build wealth over time.
I hope that you’ve enjoyed this article and it’s given you some things to think about. Please comment below and share how you have handled your mortgage(s) over the years. Do you prefer a 15 year mortgage or a 30 year mortgage? And why?
| BONUS TIP: If all of this wasn’t enough to convince you, then consider that we live in usual times with the coronavirus pandemic. If you were to lose your job, then you’ll be glad that you went with the much lower payment of the 30 year mortgage! |
For more information on mortgages and other housing related topics, please check out our other articles.
Brad Tinnon
CERTIFIED FINANCIAL PLANNER™
24 thoughts on “Why You Should Almost Never Choose a 15 Year Mortgage”
Great article and a true eye opener. Based on the support provided i agree on why 30 year mortgage and not 15 year one. The only challenge I see is the lack of discipline to ensure that indeed the savings e.g ~$700 goes to investment and NOT other undefined use(s) as it may just appear as extra money after ones monthly expenses which would then be better directed to reduce the mortgage debt instead of it being used for stuff that one may be unable to account. That being said, my take would be to have the 30 year mortgage but make extra payments that reduce the principle without the obligation of a higher monthly payment. This is an opener for further discussion. Wonderful article for brainstorming!! Thanks Brad.
You are correct Eunice in that with a 30 year loan, people may be tempted to not invest the savings. But that is an advantage as it provides people with the flexibility of having more cash flow if they need it. Also, it really shouldn’t be much of a problem to invest the savings as long as its set up to be electronically done each month – out of sight, out of mind. Thanks for the comments!
I might be wrong but don’t you have to factor the interest paid into the calculation? Seems like if you do that the 30 year is still ahead after 30 years but only by $38,000, not $142,000. I’m not a financial guy (that’s why I’m here, lol) so I might be missing something!
Hi Matt,
This is actually a very good question and highlights the point that saving interest is not the same thing as making money. In actuality, the interest doesn’t really matter. What really matters is how much money you have in your pocket at the end of the day. So even though you’ll pay less in interest with the 15 year loan, you’ll likely make more money with the 30 year loan if you are able to invest the monthly savings. In other words, I’ll gladly pay a ton more in interest if I have more money in my pocket as a result.
Hi Brad, thanks for the article.
I was doing the numbers and was thinking that wont there be capital gains tax on the savings. Looks like 15% if your income is over 40k per year. So that would level the playing field on the savings? Or you would have to wait until retirement age to drastically reduce income to get below 40k, for most people.
Great point Darren. If you sell your investments and have a gain, it will be taxed at 0% if your taxable income is less than $40,400 (single) or $80,800 (married). Therefore, you should choose to sell just enough investments each year to stay under this income threshold. This strategy is known as Tax Gain Harvesting.
Seems I’m late to the party on reading this article, but I recently arrived at a similar conclusion as you while shopping for our first home. I have two questions related to your calculations, why would you not take the interest paid into your final outcome? As Matt stated, your actual realized gain is not $142,000 when you account for paying $104,000 more in interest over the life of the loan right? Also, why would you not factor in a base capital gains tax of 15%? I understand not considering it in the equation if your goal is to use this as a nest egg, but doesn’t the advantage switch to a 15 year product when considering having to pay that 15% when withdrawing the savings in the instance of wanting to pay off a 30 year in 15? Thanks
Interest does not need to be taken into consideration as you are voluntarily paying more interest in exchange for having a lower payment and more money to invest. All that matters is how much money you have at the end. And you do that by calculating the results for both the 15 and 30 year loans.
Regarding taxes, it depends on where you invest. If you invest into your 401k or IRA then you’ll likely pay income taxes. If you invest in a non-IRA investment account you will likely pay a combination of income and capital gains taxes. I did not include taxes in my analysis, but they would be applied to the savings of both the 15 and 30 year loans. The advantage would not automatically switch to the 15 year loan just because taxes are factored in. Your savings amount under both options would be taxed in the same manner so the account that has the higher value would be the winner. And in my analysis that was the 30 year option.
I feel like something missing here is that most people won’t hold the home that long. On the 15 year, you’re making larger payments on the principle, and those payments would exceed the difference between the two loans. It’s true that in the long run, over the life of the loan, the compound interest on the investment growth wins. But a huge percentage of people won’t hold the house that long. If you sell your house in 5-10 years, for example, you’re almost certainly better (and safer) with the 15 year.
What your missing is the subsequent 30 year mortgage that you would purchase. So, even if you’re only in your current home for 5-10 years, you still have to purchase another home and choose b/t a new 15 or 30 year mortgage. And the cumulative effective of choosing a 30 year mortgage each time and investing the payment difference would likely add up to a nest egg that is larger than the amount of interest you would of paid on a 30 year loan.
But interest isn’t paid linearly on a mortgage over time. You pay much more in the early part of the loan, which effectively raises your interest rate (and thus break-even point when investing) if you sell the house early, even if you buy another house with another 30 yr loan. No?
Hi Justin. Thanks for the comment. You bring up a good point. If you don’t plan on being in your home for a very long time, then perhaps a 15 year mortgage would be best. The minimum length of time to stay in your home to make the 30 year mortgage more valuable depends on the interest rate you would receive on your investment and the interest rates on the 30 and 15 year loans. I did some quick math and if you earn 6% per year on your investment in today’s environment, then your breakeven would be around 10 years. In other words, if you will be in your house for less than 10 years then by all means go with the 15 year mortgage. So, I’ll concede that there appears to be at least 3 reasons to go with a 15 year mortgage.
Also, with 15 year mortgage, because of the large monthly payment, you are likely to settle for smaller house than the house you would otherwise purchase with 30 year mortgage.
That’s a good point Shishay. I hadn’t thought about it from that angle before.
The concept makes complete sense if you are disciplined enough to save. What I think is missing from your math is capital gains on the investment and the tax benefit of the interest deduction. Are you aware of any calculators that help with these additional factors?
If a person can be disciplined enough to pay a much higher 15 year mortgage payment, then they should be disciplined enough to save. Unfortunately, when it comes to finances there are far too many excuses from people.
The interest deduction only further improves the benefit of the 30 year mortgage over the 15 year mortgage since more of your payment is going toward interest. Regarding capital gains on the investment, you would lose a small amount of return to taxes, but that can be mitigated by using ETFs and / or tax-efficient mutual funds. But even if not, the after-tax return would likely still be plenty high enough to overcome the extra interest you pay on the 30 year loan.
The 15-year also makes sense if the property is being used an investment itself, like a duplex. You’d likely hold onto the Duplex for the entire loan term, maybe even much longer. And if you wanted to buy MORE properties, having that cash flow on hand with a 30-year mortgage gives you more flexibility. I made this mistake going to a 15-year last summer because I thought I was saving money and hoping to be mortgage-free that much sooner. But that took out about $350-400/month from my cash flow, which would have been used on the next property.
You can always sock more into the 30-year if you wanted to. Maybe you got a nice bonus, and want to tack that on to the mortgage principal. But once you’re on the 15-year, you can’t go back. You can’t do the reverse and pay less on a given month.
I think you meant to say in the first sentence that “The 30-year also makes sense….” Generally speaking you are right in that having cash flow gives you far more flexibility and allows you to build up your wealth with a 30-year loan. There are other creative ways for real estate investors to finance investment properties but I’m no expert on that. I’ll leave it up to others to chime in on that topic if they wish! Thanks for you comments Charlie!
This is great insight and has helped me with the decision point on converting our 30 year to 15 year (not to). It’s hard to accept the concept of paying more interest over the life of the loan, but when you factor in the amount you stand to gain by investing, it’s worth it. It provides more monthly financial flexibility and builds more wealth overall. I’m glad you answered the above question about the likelihood of someone not holding onto a house/loan for 15 or 30 years in that you’re right back where you started, looking for another loan. My question is kind of off topic, but would you recommend putting down 5% with a small amount of PMI or 20% and no PMI? Seems like the answer is probably 5% assuming the same principal applies for 15 vs. 30 (using leverage for overall higher wealth). Also could be personal preference.
Hi Chris. Thanks for the comments. Regarding how much to put down, it really depends on couple of factors: (1) what monthly payment a person can afford? and (2) did the person get a discount on the home purchase?
The first factor is relatively straight forward, if you can’t afford the monthly payment with a small down payment, then a person would need to increase the down payment. With the second factor, you can get away with a smaller down payment b/c you have built in equity if you got a deal on the house. In that case, you can have an appraisal done in 6 months to prove you have 20% in equity and then the PMI can be removed.
In general, I think it’s best to put down 20% if possible. PMI ranges between 0.50% to 1.00% of the loan amount. And, if you only put 5% down, the 15% you didn’t put down would have to earn over 6% to cover the cost of the PMI (at 1.00%).
Strongly suggest people run their own spreadsheet as your mileage will vary!
For example, TODAY, if you take median house price of $269k, a mortgage of 80% (20% down) with interest rates of 4.47% (30yr) & 3.68% (15yr) and an assumed ‘investment rate’ of 5%. The 15 year mortgage makes you $135k MORE than the 30 year (at end of 30 years).
You’d have get a 7.5% investment rate for the 30 year to make sense (that seems pretty aggressive).
All of this is numbers driven and you definitely need to build your own spreadsheet using TODAY’s numbers. With changing rates, tough to make a blanket call on your direction.
100% Agree Chris!
Another wrinkle I would add to this regarding the 15 year loan is once it is paid in full, there still is a bill for taxes and insurance. So, the full mortgage payment would not be going to an investment account since you will still be paying these expenses quarterly/yearly. If you don’t eat into you pocket more, you would only be investing the difference after these expenses are subtracted. This gives more edge to the 15 year. Also in the real world mortgage payments only increase year to year given taxes and insurance tends to increase.
This is not true at all. Taxes and insurance are the same under both the 15 and 30 year mortgage so they are a wash. Further, if a 15 year mortgage costs $2,000 and a 30 year mortgage costs $1,500, then you are still paying $2,000 per month under both scenarios. With the 15 year loan, $2,000 per month goes to the mortgage in years 1-15 and then gets invested in years 16-30. With the 30 year loan, $1,500 per month goes to the mortgage and $500 per month goes to the investment for years 1-30. As you can see, this has nothing to do with taxes and insurance; only the mortgage payment.