30 Year vs. 15 Year Mortgage Income Tax Deduction

Earlier this week, I compared the real cost of 15 and 30 year mortgages of $200,000 at the current market rates, assuming 4% inflation on average over those years. It turned into an interesting discussion that’s well worth reading. The high point:

The fifteen year mortgage is still cheaper, but by much less than before. In today’s dollars, the total you would pay for the 15 year mortgage is $232,835.04, while you would pay $265,187.14 for the 30 year mortgage, a difference of $32,352.10.

Also note that on a $200,000 loan, you’ll pay $102,040 in total interest with the 15 year loan, but $242,378.80 in total interest with the 30 year loan. If we average this across the length of the loan, you’ll pay an average of $6,802.67 a year in interest with the 15 year loan and $8,079.29 a year in interest with the 30 year loan, a difference of $1,276.62 the first fifteen years and $8,079.29 a year the last fifteen years of the loan.

That seems like a lot of interest, but remember that this interest is tax deductible. If you’re in the 28% tax bracket, by getting a 30 year mortgage over a 15 year you’ll save an average of $357.46 more each year on your income taxes for the first fifteen years, then an extra $2,262.20 a year for the last fifteen years – that’s actual savings, not the amount you can deduct.

If you calculate that savings in today’s dollars (so that it can be subtracted from the cost of the 30 year mortgage in today’s dollars from the first quote), it’s a total savings of $18,657.97, making the difference between the 15 year and the 30 year mortgage, in today’s dollars, only $13,694.12. This assumes 4% interest and that the tax rates won’t change over the next thirty years, of course. If inflation goes up to about 5%, you’ll be very close to breaking even.

What does this mean? The real dollar difference between a fifteen year and a thirty year mortgage isn’t as much as is commonly said; in fact, when you take all of the numbers into account, the difference begins to look quite small. If a thirty year mortgage makes your month-to-month budgeting work while a fifteen year makes it very tight, don’t talk yourself into a fifteen year because you’re envisioning a great deal – likely, the tightness of your budget will eventually eat up the amount you save unless you’re an extremely careful budgeter.

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  1. Amanda says:

    Good post, Trent. Unfortunately, that doesn’t take into account that inflation is about to go up – way up. The government is printing more currency out of thin air every day in an effort to stave off a recession. They won’t win. They can’t. And yes, tax rates are very likely to go up significantly over the life of a 30-year mortgage. Still, if the extra couple hundred dollars a month difference between the payments on a 30-year and 15-year mortgage will really help a person (especially with the coming wage contractions) it makes sense – from a personal, if not a monetary standpoint – to go for the cheaper monthly payment. After all, it could mean the difference between losing and not losing your house.

    Try reading the commentators at LewRockwell.com. It’s not a conservative or liberal issue. It’s a government fraud issue.

    http://www.lewrockwell.com/north/north500.html
    http://www.lewrockwell.com/paul/paul380.html
    http://www.lewrockwell.com/paul/paul333.html

  2. JLP at All Financial Matters covered this (better, IMO) a couple of months ago:

    http://allfinancialmatters.com/2007/03/07/check-out-the-latest-dave-ramsey-poll/

    Instead of taking inflation into account, JLP says “what if you took the extra money and put it into a mutual fund or other investment earning 8% a year?”. E.g. if you have a 15-year and a 30-year mortgage with $1700 and $1200 payments, respectively, take that extra $500/month and put it into such savings for the entire duration of the 30 years, on the 30-year loan, and taking the $1700/month after the 15-year loan is paid off and putting the entire amount into the same savings after the 15-year is paid off, for the last 15 years of the 30-year comparison period. The net worth of the person with the 30-year mortgage comes out ahead.

    I tried to throw in some discussion about inflation in the comments to JLP’s post, but I think I got myself confused. Inflation would hit the two 30-year outcomes the same way, by reducing each by a certain percentage. This would necessarily affect the higher amount more, lessening the difference between the two outcomes.

  3. anonymous says:

    You forgot that with AMT many people cannot deduct their 30 (or 15 year) mortgages fully.

    I think this highlights at once why finances can start to feel overly complicated, but also that much of this is a choice. If you will feel better at night because your home is paid off–or being paid off quickly–and can afford a 15, by all means go for it. Otherwise, pick another option.

  4. s says:

    This only works if you assume the person has their entire standard deduction (just over $10k for two people) in “other” deductions. This is a very big assumption.

    In calculating tax benefit you should really only count the interest paid that is over the standard deduction. The “average” interest doesn’t even meet this amount, so the tax benefit over the life of either loan is probably fairly small.

  5. jtimberman says:

    Rather than stay under financial bondage – slavery to a bank – for additional years, pay off that mortgage faster, and donate what you were spending on interest to your local church or other charity.

    This has a few benefits.

    1. You’re done with the mortgage. Whether it costs less “over time” per the inflation math, you’re still not shelling out that huge payment every month, freeing up your income to pay for things and invest long term.

    2. You’re making a charitable contribution which has a tax deduction as well.

    3. By giving, you’re growing as a person. This is spiritual growth, but if you’re not a religious person you can call it character growth.

    Our current financial plan has our house paid for with in 7 years, which will free up a sizable amount of my take home pay. We already tithe to our church, so we’ll have even more money available for giving.

  6. dave lamport says:

    guys, don’t kid yourself. paying off your mortgage earlier will ALWAYS allow you to retire earlier. if you can’t afford a certain house on a 15 year mortgage, then you just can’t plain afford that house. look for something less expensive. it’s not rocket science.

  7. brian says:

    And then there is the money to be gained in investing $1678 a month for 15 years once the mortgage is paid off while your 30-year buddy is still paying on his. Without adjusting for inflation your looking at $300,000 even if you just stick it under your mattress. Doesn’t justify putting your budget into the red zone, but if you can do it comfortably, its the smart move.

  8. Minimum Wage says:

    Now I will expand on my comment is the previous thread.

    While the 30 year mortgage allows you $450 more to invest than the 15 year mortgage, this advantage lasts only for the first 15 years. If you allow this money to compound for 30 years, you will have X dollars (I don’t have a calculator handy).

    With the 30 year mortgage, your $450 is not available for investment during the first 15 years, but for the next 15 years, instead of making a mortgage payment, you have a bundle to invest. Allow this to compound, and at the end of (total) 30 years, you’ll have Y dollars.

    So the problem entails not only how much you PAY over the 30 years, but also how much you GAIN from investment during that time, and consequently, your NET position at the end.

    But if you don’t stay put for 30 years, there’s an entirely different answer.

  9. Trent Trent says:

    Minimum Wage: however, those dollars during the last fifteen years are worth a lot less than the dollars during the first fifteen years. Again, it’s closer than you think.

  10. This is really interesting. Do you have a spreadsheet that you used to make these calculations? I’ve updated buy versus rent spreadsheet I have to reflect the idea of inflation rates. If you are interested, you can find them here: http://www.potterzot.com/blog/2007/08/16/buy-or-rent-update-inflation-and-tax-breaks/

  11. disavow says:

    Adding to what s said, standard deductions are indexed to inflation, so that it gradually gets harder and harder to reach that mark–especially since mortgages are amortized so annual interest payments shrink over time. Mortgage interest is only useful if you can actually deduct it.

  12. Trent Trent says:

    That’s the fun of looking at things like this – to a degree, you have to prognosticate and make some assumptions about the future. For example, the higher the rate of inflation, the better a 30 year mortgage works, and a 30 year has higher potential to earn you tax benefits than a 15 year (that’s the point of this post).

  13. Say what you like, there’s a lot to be said for being debt-free. Count me in the 15-year camp.

  14. @brian, Minimum Wage, Trent: see my earlier comment and the linked post at AllFinancialMatters (which includes a handy-dandy browser-based comparison calculator — click the link in JLP’s post for the “Mortgage Comparison XL Calculator”) linked above. The $1678 you sock away every month for 15 years “while your 30-year buddy’s still paying his mortgage” doesn’t match the compounded $500 or so that your buddy has socked away every month for the entire 30 years. And that’s even without taking taxes into account! (as the AMT really throws a wrench into things)

    Furthermore, if you look at the situation after only 15 years, the 30-year guy will have saved up more than the payoff on the home. So, if he wanted to, the 30-year guy could pay off the house after 15 years (with a lump-sum check) and still have a few thousand left over! Of course, this is assuming the rate of return on investments is higher than the interest rate on the mortgage.

    This is the problem with the Dave Ramseyites and their “Debt Free” mantra. Would you rather be “debt-free”, or have a positive net worth? I.e. you have enough in liquid assets to pay off any debts that you have? Would you honestly feel THAT much better off with $0 debt and $0 in savings, than being $100k in debt while also having $110k in the bank? Logically you are better off under the second scenario, but it seems that many people have an emotional fear of debt that makes them choose the first scenario.

    As far as inflation, just remember: inflation ALWAYS favors the debtor. If you are predicting high inflation, then get into as much fixed-rate, long-term debt as you can. The amount that you owe, in real terms, will diminish every year.

  15. benp says:

    @Gaming the Credit System

    I would characterize the Ramseyites position as being that most people won’t invest the difference in monthly payments systematically. Personal finance is complicated with taxes, but it gets even more complicated when you factor in human psychology. IMHO the most important part of being debt free is that increases the “pain” of spending and therein reduces consumption.

  16. Chris says:

    Choosing between a 15 year and 30 year, or fully amortized versus interest only, I would always go with the longest term, least payment possible. The reason is because you can always pay extra if you so desire. But, should trouble arise, at least you have secured the lowest payment possible to get through those tough times. This is of course most effective if you are a responsible, financially astute person. I do know some people that, if it were not for the equity they build up in their home by paying down their fully amortized debt, they would have no savings at all.

  17. In one sense, the debate is pointless. A 15 year payment on a $200K house is $1678. A 30 year payment on a $273.2K house is $1678. Most people will opt for the larger, more beautiful, $273.2K house and not the smaller $200K house. Realtors, banks, etc. push for the larger house since it earns them more fees. Most people will not settle for the $200K house and save the difference (which, as Gaming the Credit System, points out is a winning strategy in an poorly-run, inflationary economy).

  18. vh says:

    Trent, for the dumb & the feckless among us, would you please explain about the extent of tax deductibility of mortgage payments? This is something I’ve never been able to figure out,(Because my financial picture is pretty complex, a professional does my taxes, so I haven’t been forced to ponder it through.) From what I can understand, you can’t deduct the entire cost of mortgage interest–you only get a fraction of it, right? Wouldn’t that mean that over time, as the portion of the payment that’s interest drops, the value of the payment in terms of its deductibility would also drop, & pretty significantly?

    What proportion of mortgage interest can you actually deduct, assuming you have a household income of, say, between $43,000 and maybe around $60,000?

  19. viola says:

    It basically comes down to personal comfort with the choice, but don’t be fooled. The falacy of the arguement that 30 yr is ok assumes that your assumptions are correct. Your assumptions about whatever will occur tax & inflation wise for 15 years has a higher probability of being right over what will happen for 30 years, unless you have a crystal ball.

    Also you incorrectly assume that someone will always be getting the tax deduction for the interest they pay. First you would have to exceed the standard deduction, which is currently going up ever 1-2 years. Then your income has to be 1 earner (or low). Then you would have to be dumb enough to give away a dollar to get 30 cents back and be happy about it. That’s what interest is.

    Also the debate varies significantly based on the interest rates. When I bought my home 4 years ago, I got 4.75% for 15 year, while 30 year was 5.75%. If the rates are closer, there are less differences of course.

    I honestly like the idea of having my house paid off before I have kids in college, since I don’t have kids yet. The ease of financial burden is priceless to me.

  20. Brent says:

    The tax deduction for interest is a very poor argument. Given two options…

    1) Give money to charity, and deduct it

    or

    2) Give money to the bank and deduct it

    There is a whole lot more good coming out of giving that money to a charity.

    The decisions we make with our money affect more than just our own lives. Many people justify too much house, too much interest by saying it is deductable, like they are going to get it all back.

    You need to redo your calculations to get them more on an even footing.

    Include the gains from 15 years of mortgage payments being invested.

  21. Shawn says:

    The whole tax deduction argument is ridiculous. You’re paying 72% to save 28% on your taxes!. As someone else said donate the money to a charity instead. Plus as someone else pointed out the amount you need to itemize is going to continue to climb to the point where you’re not going to be able to deduct the interest anyways. Just pay off the damn mortgage.

  22. Brent says:

    Ok, for all of those anti Dave Ramsey people.

    It all comes down to Risk.

    Being Debt Free, removes a lot of risk from the equation.

    If you live your life without a 30 year burden over your head, you will have more capability to take advantage of opportunities as they arise.

    If every day has a 30 year obligation hanging over me, I am less agile financially.

  23. Debbie says:

    One more note. Most people aren’t in the 28% tax bracket. I currently make about an average salary and I’m still in the 15% tax bracket and I don’t even have any dependents.

    I do deduct some of my interest but that’s only because I also deduct charitable contributions. If I didn’t, I wouldn’t have enough to exceed the standard deduction.

    That said, it’s also true that the amount of interest looks very different at the end of your mortgage than at the beginning. Even the amount of principal plus interest (P&I) looks very different. When I first bought my house 11 years ago, my monthly payments were just over $600, and just over $500 of that was P&I (mostly interest). Now my payment is $800 per month, and of course P&I is still $500 (over half is now pricipal).

    By the time my house is paid off, my taxes and insurance (not to mention maintenance costs) might be just as high as my P&I was. Still, it’s nice to a) quit having to pay out $500 of that money per month and b) not have to pay how much it would cost to rent such a place (currently $900-1200/month where I am).

    (Note: obviously I do not live anywhere crazy expensive. Also, my house was about 2/3 the price of the average house at the time I bought it because it’s small.)

    (Full disclosure: I started with a 30-year mortgage because it was all I could officially afford. Two years later I refinanced to a 15-year mortgage with lower interest. Another advantage was that since I had been paying extra each month, I had enough equity to significantly reduce my mortgage insurance payment each month as well. I admit that the mortgage rate spread between 15- and 30-year loans was only 0.25% at the time. I am definitely biased to want this house paid off ASAP but am not allowing myself to send in extra payments because I know I can make more via other investments.

    Also, if I wait until the house is paid off to invest in the stock market (other than in retirement accounts), then I am reducing the span of time during which I will be invested and thus increasing my risk. I am extremely risk averse but do feel that investing in the market is the best hedge against inflation. Well, inflation-indexed bonds used to be pretty good as well, but I only got a few I-bonds back when they were 3% + inflation and now the deal isn’t that great.)

  24. Ted says:

    The old “tax deduction” analysis is fallacy. Yes it helps a little, but it is not a leg to stand on.

    First most people do not already meet the standard deduction threshold. Unless you already have >$5,150 in deductions as a single or double that if married, Trent’s analysis is worth what you paid for it.

    Even in the best case, do you really think its good math to send the bank $10,000 so you don’t have to send the government $2,800? I’d rather send the government the $2,800 and keep $7200 for myself to invest.

  25. devil says:

    Interesting post and comments. Lots of points to think about.

    I tend to look at most life matters as simply as possible. We took a 15-year mortgage because we could foresee paying it off one day. I just couldn’t imagine ever paying off a 30-year loan. People do, I’m sure. It just seems too long to pay off anything.

  26. Tristan says:

    Mortage=Risk,

    No Mortgage=No Risk=No interest payments=you work for yourself not the bank.

    Debt is never good. It’s enslavement. There is no true advantage to keeping debt.

  27. Trent Trent says:

    Tristan, overextending your budget is risk, too.

  28. Andy says:

    Okay, I am a pastor, and the money I spend on my mortage is not taxed (plus I get the usual tax benefits). This makes spending down my mortage a great deal, I figure. There is, however, a limit to how much I can spend on my mortage per month. So I figure the smartest thing for me to do is to have a 30 yr and pay it off as fast as I can to take full advantage of this tax break. If I run into financial trouble, I can ease up on the payments. By the way, I don’t feel guilty at all about this special tax break — I have a three year masters degree and get paid less that most people who only have a bachelors.

  29. Kevin says:

    honestly how do any of you not top the standard deduction? I usually have almost double in itemized deductions vs the standard. I fail to see how anyone who has been in a house less than 7 years could not beat the standard deduction.

  30. icup says:

    @Andy – Why should you feel guilty even if you got paid lots of money? Thats the nature of a benefit. I get a free laptop from my job and don’t feel guilty at all. I say enjoy it, guilt free buddy. You earned it.

  31. Engineer says:

    Kevin: “honestly how do any of you not top the standard deduction?”

    Let’s take a married couple. Standard deduction is $5350 for a single, $10,700 for a couple. Let’s say combined income for the couple is $70,000 in a state with a 6% income tax. That’s $4200 of deduction to which we’ll add $3000 of property tax for a total of $7200. So the difference between $10,700 and $7200 or $3500 of mortgage interest really isn’t deducted at all, only that portion of mortgage that exceeds $3500.

    Perhaps your situation is different. Yes, you may “top the standard deduction”. But really, how much of your mortgage interest that you pay exceeds the standard deduction? Or stated another way, after you fill out schedule B, does the amount by which your deduction exceeds the standard deduction also exceed your mortgage interest?

    Some of you will be able to answer the question as “Yes”. But if not, then part of your mortgage interest really wasn’t deducted.

    So Kevin, do your schedule B deductions ignoring mortgage interest exceed your standard deduction?
    To anyone else, same question.

  32. John says:

    Tristan,
    “No mortgage = no risk” is absolutely, 100%, false. It’s actually possibly RISKIER than the stock market (with proper diversification). Because you’re tying up a huge portion of your money in a single investment, you could lose a huge portion of your money if that investment should decline in value for whatever reason. Yes, it’s less volatile than the stock market. But it’s not necessarily less risky. A lot of people are finally figuring that out in the current housing slump. A house is an investment and carries risk like any other investment. I’m worried that you aren’t evaluating risk properly, which could make you vulnerable.

  33. Bill says:

    What’s the endgame?

    I know people who took 15 year mortgages to make sure they’d have the flexibility to leave their 9 to 5 job when the mortgage was paid off.

    And over the long term, residential real estate has only returned 1.5% in real terms.

    One thing to consider is that property tax is not capped in most jurisdictions.

    Even here in flyover country the tax assessed value of the large house where I grew up is 10x what it was 25 years ago – current property taxes of $1200/month – I don’t think most people’s income has increased the same.

  34. Morgan says:

    I disagree that you think a 30 year loan works out to being even close to a 15 year as far as what is good for the person… let me explain why a 15 year loan will ALWAYS be better for you… It is actually simple when you take into account what the saving will be at the end of the 15 year loan. You then have no debt and do the smart thing and invest the money you are now saving each month. the 30 year guy is still paying his interest (who cares how low the rate is it’s still money out the door) while the 15 year guy is now earning money at lets say even a 10% rate or return… THAT MEANS FOR 15 MORE YEARS HE’S ALMOST DOUBLING HIS MONEY THAT THE 30 YEAR LOAN GUY IS STILL PAYING.

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