Is the 15-Year Mortgage Better than the 30-Year Mortgage?
Buying a home is a major financial decision with a lot of other emotions wrapped up in the purchase. Making sure that you’re equipped with the right knowledge can help make the buying process smoother and help you for decades to come.
This brings us to the important question: is the 15-year mortgage better than the 30-year mortgage? Let’s explore the advantages and disadvantages of both options, from a Prosperity Economics perspective.
What is a “Typical” Mortgage?
The 15-year mortgage:
- Less cumulative* interest paid
- Lower interest rate
- Shorter time, higher payment, lower monthly savings
- Any additional cash flow applied to the mortgage to build home equity
- Some inflation benefit
- Some interest deduction
Now, in isolation, these bullet points all seem like great selling points, right? For many people, a lower interest rate and paying less cumulative interest are enough to sign the papers right away. People also like the idea of a quick payoff.
Even so, there are some critical considerations that make a 30-year mortgage the clear winner, if you can set aside your pre-conceived notions for a moment.
What is a “Prosperity Economics” Mortgage?
The 30-year mortgage:
- Less actual net compound** cost
- Higher interest rate
- Longer time, lower payment, higher monthly savings
- Any additional cash flow applied to a “side fund” builds savings outside of the equity
- More inflation benefit
- More interest deduction
When you look at it this way, a 30-year mortgage sounds pretty good, right? While many people balk at such a long repayment period and the thought of paying so much interest, the truth is that with a solid savings strategy, those with a 30-year mortgage come out on top.
If you’re not convinced, let’s look at the idea in action.
Comparing the 15-year and 30-year Mortgage
Let’s say your friend Suzie is buying a $250,000 with a loan from the bank. At her bank, the 15-year and 30-year financing options both carry the same interest rate of 4.5%. If she chooses the faster repayment schedule, her payments are about $1,912 while the longer repayment is a little easier on the wallet at $1,266. Even so, Suzie is hesitant to take a 30-year loan because it seems so daunting. And that’s more interest cost, right?
To illustrate Suzie’s situation, we’ve used the Loan Analysis calculator from Truth Concepts, financial software created by my husband, Todd Langford.
At a glance, it seems like the 30-year mortgage is going to cost Suzie WAY more in interest in the long run. Case closed, right?
Not exactly. The thing is, what we have not yet considered is the time value of money (aka Opportunity Cost).
The Cost of Cash
First, let’s consider what it would look like if Suzie had the cash to pay for the house up front. She’d save ALL that money on interest, right? Mathematically, that’s true that she wouldn’t PAY interest. However, what Suzie would be losing is the opportunity of saving that $250,000 so she’s actually losing interest EARNED.
If we use the Future Value calculator from Truth Concepts, we can see that if Suzie were to EARN 4.5% on her $250k that she would have almost a million dollars after 30 years just for letting the money sit somewhere and compound. This means that if she chose to pay cash for the house, she loses the opportunity to make over $600k.
So although paying for cash SEEMS like the most logical option, Suzie is actually losing out on a major opportunity in the long-term. And you might be thinking that if she were to take the mortgage, wouldn’t the interest she pays just wipe out the interest she earns?
You might think that, but if you look at our first image, you’ll see that Suzie would pay about $94k of interest on a 15-year mortgage or $206k on a 30-year mortgage. In isolation, those are big numbers. Yet that interest happens over 15-30 years. The BEST option, it seems, would be to take a mortgage and save the $250k. In 30 years, she would have a Net gain of of $700k and a house she owns free and clear. If she chooses to pay for the house in cash anyway, Suzie is giving up $700k just to save $200k of interest cost.
The Cost of Mortgage Payments
If you’re following our thinking here, your next question might be, “Okay, so she saves her cash, but even so, why would Suzie take the 30-year mortgage over the 15-year mortgage?”
Let’s think about those time frames. Let’s look at the opportunity cost of each mortgage. If you plug in the monthly payment on each of the mortgages, and analyze them over the length of their loan (360 months or 180 months) you get the following:
The 15-year (180-month) mortgage still seems better! Right…?
What makes this comparison misleading is the fact that they aren’t compared over the same time frame. So let’s extend the time frame to the same 30 years that we analyzed the cash payment and the other mortgage.
So for example, instead of paying $1912.48 over 15 years, what if Suzie saves those monthly payments? She would stop saving at 15 years, because that’s the length of the mortgage; however, the account is still there and able to earn money. If she leaves the account intact without any additional contributions for the next 15 years, she will have the results below:
That’s right. The opportunity cost is the exact same whether Suzie pays in cash, pays over 15 years, or pays over 30 years.
So are any of these options better, if they ALL cost the same in the long run?
With opportunity cost in the equation, revisit our “Prosperity Economics Mortgage” list above. Hopefully, it should be clearer now why the 30-year mortgage is the even better option.
Lower monthly payments allow Suzie to save more money from day 1, if she chooses to employ a “save the difference” strategy. This strategy has advantages because Suzie will be building her emergency/opportunity fund right away.
Many people who choose a 15-year mortgage do so with the hope that they’ll pay the house down first and save later. Unfortunately, life happens, and it’s rare that you’ll go 15 years without an expensive surprise. Being in a position of liquidity in those events is preferable.
Saving the Difference
So let’s say that Suzie chooses a 30-year mortgage and is committed to saving the difference between payments. By saving into a whole life insurance policy, Suzie can get a higher rate of savings than a typical savings account. (Which means that yes, a 4.5% savings rate is possible/realistic).
An additional advantage is that if Suzie wants to dip into her savings, either due to an emergency or an opportunity, she can do so without reducing her account, thanks to the policy loan provision. This means she can continue to experience the maximum amount of compound growth.
Here’s what it would look like for Suzie to take a 30-year mortgage and save the difference at the same rate:
You’re seeing that correctly. At the end of 30 years, Suzie would have accessible cash that equals the opportunity cost of 15 years of high payments. Let alone another 15 years of compound growth after that!
Sure, that means that Suzie could achieve the same thing by putting her nose to the grindstone and paying off her house for 15 years first, THEN saving at her mortgage rate for the following 15 years. However, this puts her in a very precarious position while she’s paying down the house. A lot of things can happen in 15 years, and especially when you own a home.
Oh, and that inflation benefit? If we use a Present Value calculator, we see that Suzie’s very last payment will only feel like $329 of today’s dollars. A 15-year mortgage won’t get inflation benefits quite like that.
15-Year Mortgage Myths
- Equity increases the value of the house
- More equity increases the owner’s financial strength and provides more control
- Safer risk position from cash flow reduction issues (loss of job, disability, emergency)
- Cumulative* interest paid is the cost of the mortgage
The reality is:
- Higher equity reduces the loan balance but does not affect the value of the house which is determined solely by the market.
- More equity causes less negotiating strength with the financial institution. To access the equity, you must sell the home or qualify for financing to borrow against it.
- Extra equity can cause a loss of the property due to a reduction in the amount of available cash outside of the house for emergencies.
- Total payments minus the tax deduction compounded** at a COM*** rate is a real cost.
So, Is the 15-Year Mortgage Better Than the 30-Year Mortgage?
With all of this to consider, a 30-year mortgage really seems like the right way to go. It keeps you in control of your assets and your home. It provides the option to keep money where it’s liquid and accessible, not locked up in home equity.
Ready to buy a house and jumpstart your savings? Chat with us about the right whole life insurance solutions for you, so that you can have an emergency/opportunity fund that gets the job done.
*cumulative: simple addition of all payments
**compounded: payments grown by an interest rate over time
***COM: cost of money. A personal earnings rate based upon a weighted average of savings or investment earnings and financing rates currently experienced (i.e. 4%)
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