Fixed Rate Mortgage: 15 year or 30 year Mortgage?

I recently read an article at Finance is Personal entitled Why You Shouldn’t Get A 30 Year Mortgage. It presents a great argument for why one should get a 15 year mortgage and not a 30 year mortgage – you pay fewer dollars in the long run because of the lower interest rate and fewer years to accrue interest.

However, Matthew, the author of the article, neglected to take interest into account in his comparison of mortgages, so I started running the numbers. I went to Bankrate.com and found that the current average rate for a 15 year loan is 5.91% and a 30 year loan is 6.23%. Let’s assume also that we’re getting a $200,000 loan and that, over the next 30 years, inflation will happen at a rate of 4% a year.

For the 15 year loan, you’ll make a monthly payment of $1,678.00 each month for 15 years. If you just directly add up the dollar amount of the payments without worrying about inflation, the total of your payments would be $302,040.00.

For the 30 year loan, you’ll make a payment of $1,228.83 each year for 30 years. If you just directly add up the dollar amount of the payments without worrying about inflation, the total of your payments would be $442,378.80.

So, on the surface, it looks like the 15 year mortgage is a far better deal, saving you $140,338.80. But there’s a big flaw with that number: if inflation goes up every year, the dollars you spend in the early years of the mortgage are worth far more than the dollars at the end of the mortgage.

Let’s look at the loan entirely in today’s dollars and assume inflation will be 4% from here on out. This means that for the first year, each dollar you pay is worth that same $1 in today’s dollars, but next year, each dollar will be worth only $0.96 in today’s dollars. In the final year of the thirty year mortgage, each dollar you pay on the bill will only be worth $0.32 in today’s dollars.

What’s the final result? The fifteen year fixed rate 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. While significant, it is not the stunning difference that appears when you don’t take inflation into account.

In fact, if you believe inflation is going to be higher than 4%, a 30 year can actually be a better deal. With today’s interest rates on the 15 and 30 year fixed rate mortgages, the 30 year mortgage is actually cheaper than the 15 year mortgage if inflation averages 7% (or higher) a year over the next 30 years. It only takes a few years of Jimmy Carter-esque stagflation to see inflation skyrocket far above that, and some people believe inflation may already be that high from the perspective of the lower middle class where items like gasoline play a large part in the monthly budget.

What’s the moral of the story? Inflation sometimes tells a different tale than you might initially think. Using it here, it’s pretty clear that a 30 year mortgage isn’t nearly as bad of a deal as some might make it out to be – and it might even be a good one.

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  1. Bob says:

    $1,678/month, adjusted for inflation or not, is a lot of money to put in your pocket while the guy with the 30-year is still shelling out for another 15 years.

    A couple more things:
    1. If possible, a reasonable risk factor should be incorporated whenever you do these kinds of calculations; and,
    2. Until someone out there quantifies a “peace of mind” factor that comes with owning your house outright, I will always side with the shortest mortgage term possible.

  2. Ted says:

    This is interesting but has very little real world practicality. How many people actually 1) stay in a home 30 years, and 2) pay off their original 30 year note without a refi? And who knows what inflation is going to do anyway?

    If you look at the difference in the amount of interest sent to the bank and saving the balance you come out way ahead with the 15 year note.

  3. Paul says:

    Interesting article…

    A more interesting comparison might be is it better to get a 15 year loan at a higher payment, or is it better to go for the 30 year loan and make additional principle payments.

  4. Great post. This incremental exploration is what I love about the PF blogging community. Any time someone posts an answer to a question, there’s always someone else to add insight or refine the conclusion.

    One thing, though: should “the author of the article, neglected to take interest into account” be “the author of the article, neglected to take inflation into account”?

  5. Adam says:

    Very interesting comparison.

    I like the “dollars only” approach of this article, but I still would like a 15-year (and pay it off quickly), because I want to OWN my house.

    This is still a good technical article for those making this decision.

  6. 1. You only looked at the mortgage over 15 years and 30 years. What happens when you save your mortgage payment for the next 15 years while the 30 year mortgage is still being paid off?

    2. What happens when you save the difference (~$450) in the 30 year mortgage vs. the 15 year mortgage.

  7. David says:

    I did this exact same comparison with a friend about a week ago! It is indeed amazing to see how little difference it makes. Not to mention, as Lifeguard1999 said, the extra money you get each month. If that goes into investment around 9%, you easily make back any loss on the 30-year, and make more in the long run.

    However, my friend is not planning to live in the house more than 7 years or so, so I advised the 15 year. He does not expect the value of the house or land to increase dramatically, So by getting a 15-year mortgage, he will make more money on the house when he sells it, enabling him to get a slightly better home next time around. He is buying slightly less than he wants now to make up the extra monthly costs.

    It is fairly clear that if you plan to stay there long-term, a 30-year is almost always better.

  8. Cory says:

    I find it amusing that in the first comment Ted stated “And who knows what inflation is going to do anyway?”

    Well the answer would be that Trent is simply using past history to predict future results. While doing that when buying a stock, etc. is a horrible idea, how else do you suggest taking inflation into consideration when planning for
    your financial future?

    BTW Trent I absolutely love math posts like these, keep it up!

  9. dave says:

    a recent financial study shows that people who pay off their mortgage early will retire 5-10 years earlier, on average, compared to someone who doesn’t. thats all i need to know. 30 year mortgages are for mugs(or for people who are living beyond their means).

  10. Dan says:

    Our experience in the Midwest provides a different reason to choose a 15 year mortgage.

    We moved after living in our house for 6 years. (This is about the average amount of time folks in the US own a house, I am told). Due to downswings in the real estate market here in the Detroit area, after 10 months on the market, we ended up selling our house for about $30,000 less than we paid for it.

    After a 7% commission to the real estate agents (we bumped up the commission to make the sale) we netted some money back, but if we had a traditional 30 yr, instead of a 15 yr mortgage,
    we would have had to bring about $8,000 to the closing just to make up the difference.

  11. Jamie says:

    Going further with the math…

    With 4% inflation, the $200,000 home is worth $662,700.

    If the 30yr mortgager takes the difference in mortgage payments every year and invests at 6%, at the end of 30 years he will have paid $442,379 to the mortgage, and have $451,198 invested.

    If the 15yr mortgager takes his mortgage payment at the end of the 15 years, and invests at 6%, at the end of 30 years he will have paid $302,040 to the mortgage, and have $487,994 invested.

    However, at a higher interest rate, the 30yr mortgager starts to get ahead. At an interest rate of 6.73%, the 30yr mortgager is up $100 with an investment of $519,657.

    At 7%, he’s up $16,112; 8% is $88,773; 9% is $187,350. At a 10% return, the 15yr mortgager has $695,000 compared to the 30yr mortgager’s over $1,015,000.

    If you can manage a decent rate of return, even a trickle for a long time works out very well.

  12. Rick says:

    To address Paul’s (2nd post) comment, I did run the numbers. Using the rates available when I bought my house a few months ago, I figured if I got a 30-year loan, but made the payments I would need to make for a 15-year loan, I would pay off the 30-year loan in 15 years and 10 months.

    Consider a $200,000 house. Say the rate on a 30 year loan is 6.25%. The rate on a 15 year loan is 6%. If you took out the 15 year loan, your total monthly payment would be $1687.71. Now let’s say you took out a 30 year loan. Your monthly payment would be 1231.43, a difference of $456.28. Now, let’s say you took out the 30 year loan, but made an extra payment each month of $456.28, so your payment is the same as the 15-year loan payment. You’ll end up paying the loan off in 185 months. That means by choosing the 30 year loan, your only cost is an extra 5 months of payments.

    That’s why I chose a 30 year mortgage. I have an added flexibility by having a lower *required* monthly payment. If I run into some sort of financial difficulty, my monthly obligation is less than had I chosen a 15-year mortgage. And the cost for this added flexibility is just 5 months.

    (I ignored complexities such as a different tax benefit, and inflation)

  13. Citoahc says:

    Something else to keep in mind…
    With Bank of America a 200k Mortgage with 20% down is $1382.80 per month over 15 years and $1037.76 over 30.

    If you take the 30 year mortgage and save the difference at 5.05% you end up with 290k after the 30 years. If you take the 15 year mortgage and save the $1382.80 every month for the second 15 years you end up with $371k. That is 81k in favor of the 15 year mortgage.

  14. plonkee says:

    I hope to goodness inflation never reaches 7% again – unless of course that is matched by my salary increasing by 8% at least.

  15. John says:

    > people who pay off their mortgage early
    > will retire 5-10 years earlier, on average

    Another way to read that would be: people who’re rich enough to retire early also have the spare cash to pay of their mortgage early.

    Correlation does not prove causation:
    http://en.wikipedia.org/wiki/Correlation_does_not_imply_causation

    > thats all i need to know.

    Actually it’s not.

  16. AndyK says:

    This is such an awesome website and always look forward to checking back daily here…

    I, being a 25yr old male, living in the Bay Area (Ca.), am hoping to purchase a house in the next year or so and have roughly a 100k downpayment. I always smile to myself and become jealous of the people who live in decent price states. In the Bay Area, pricing for a decent, half fixer up’er house start around $600k. A decent house in a decent area starts around $700k

    Sounds great to be able to pay off a morgage in 15yrs, but… some of us, (like myself) will have
    to take a 30yr morgage and hope to have it payed off earlier (plus $8k+ year in property taxes etc..).

  17. Engineer says:

    An interesting perspective, one worth considering.

    I took Trent’s numbers for the 30-year mortgage, and using a spreadsheet remodeled the payments a bit. The first year they are per the loan agreement, but each year after that the payments increase by 4% to match the assumed inflation rate.

    With the revised payment plan, the 30-year mortgage is paid off in less than 17 years. The payment amount equals and then exceeds that of the 15-year note after 8 years, but as Trent points out they’re with cheaper dollars.

    Plus you have the option of dropping your payments to the regular amount if you have a financial rough spot — for instance to stretch out your emergency fund if you lose your job.

  18. Eido Cohen says:

    A few comments on Trent’s enlightening exercise:

    1) A small quibble with Trent’s figures:
    Assuming a rate of inflation of 4%, then the true interest on the 15-year mortgage is 5.91-4=1.91%, and on the 30-year mortgage 6.23-4=2.23%. Thus, if you amortize these figures for a $200,000 loan, your true costs in today’s dollars are $230,174.21 for the 15 year mortgage and $274,483.30 for the 30 year mortgage, for a difference of $44,309.09 (and not $32,352.10 as Trent says above). You’re welcome to check my figures at http://www.amortization-calc.com/

    2) Also, an unstated assumption of Trent’s example is that these are straight fixed-interest loans, and not 5/25 or 7/23 balloon mortgages that require a reset of the interest (with a requisite re-financing) 5 or 7 years, respectively, down the line.

  19. Eido Cohen says:

    A further comment about what Trent says here:
    “It only takes a few years of Jimmy Carter-esque stagflation to see inflation skyrocket far above that, and some people believe inflation may already be that high from the perspective of the lower middle class where items like gasoline play a large part in the monthly budget.”

    The true increase in the cost of living is not just found in the price of gas. Look at the annual cost increase in a college education, which is rising at an average of 10% per year. Or look at the 50% spike this year alone in the cost of corn due to increased demand for ethanol and the artificial price supports of the U.S. Farm Bill.

    As an aside, the average cost for unleaded gas in the U.S. is extremely low in comparison to other industrialized nations, where in Europe for example, the cost of gas at the pump is over $7.00 (at the present exchange of euros to dollars). The increase in Europe consists of taxes, which provides some disincentive for driving and provide an incentive to use public transportation (such as light rail, high speed trains, subways, and buses) – which is of MUCH higher quality and utility in Europe than in the U.S.

    So, to continue my main point, if you look at the Federal Reserve numbers for M3 (which the Fed stopped to publish in March ’06, ostensibly to save $2.5 million in costs a year), which is the broadest measure of the money supply, M3 increased in 2006 by 13.7%. The main reason the increase in the money supply does not increase inflation by a commensurate amount is that the dollar is still a “hard” currency that can purchase petroleum, and the nations of the world are still absorbing the “excess” dollars put into circulation. One day the world will not need the U.S. as much as today to “consume” their products, and large holders of dollars will use their huge holdings of U.S. treasuries to manipulate U.S. foreign policy. To wit, last week China threatened to liquidate much of its holdings in U.S. currency if the U.S. govt. imposes trade sanctions to force a yuan revaluation. See this U.K. Telegraph article http://tinyurl.com/267s4n.

    For me, it is a matter of not IF but when a recession/stagflation and double-digit inflation occurs due to the Fed’s manipulation and debasement of the U.S. money supply. I learned a great deal about this through http://www.mises.org if anyone wants to get a deeper understanding of my perspective.

  20. Brad says:

    I live in Michigan, have a 30-year fixed mortgage and will most likely stay in the house for the rest of the mortgage term. I bought more house than I needed (4 bedroom, 2 bath), so we have no need to upgrade in the future.
    We didn’t get a 30-year to get more house than I we afford, as one poster generalized. It’s just a better fit for us. The difference from a 15-year can be used on vacations and the odd home improvement. However, when we have 20 years remaining on the mortgage, we are switching to a 15-year to pay it off 5-years early. Planning for that so we can throw the mortgage payment amount into 401/457 accounts. Seems to make sense to me. Anyone think it’s a daffy idea?

  21. Engineer says:

    @Brad:
    Have you factored in the cost of refinancing: appraisal and other closing costs?

    What would happen to your current mortgage if you threw $2000 against the principal (or whatever the closing costs would be) and then starting increasing your payments to what the 15-year loan would be? Might turn out to be cheaper and paid off sooner. Spreadsheets are great for doing this what-if? projections.

    You’ve already indicated you plan to stay in the house another 20 years. But life happens and something may change your mind in a few years.

    Off the top of my head, I doubt this approach would be to your advantage, unless you could get a much lower interest rate. When the time comes, and you have a better picture of what interest rate you could get and what your personal situation is, model the numbers and see what they tell you.

  22. Darrell says:

    Why use 4%? That’s not the most recent annualized inflation rate at the time of this comment (2.36%), and it’s not the long-term average inflation rate (which is 3.63%).

    Get statistics on inflation here:
    http://www.inflationdata.com/inflation/

  23. Brad says:

    thanks Engineer, that makes more sense than my idea. I completely forgot about refi costs and all the silly fees they attach, not to mention the apr at the time I would refi.

  24. Trent Trent says:

    Darrell, the inflation rate you’re quoting is the CPI-U, which is only one potential measure of inflation and it’s one that many people criticize as being flawed because the weighting of various expenses doesn’t match the real life of many people. Housing, for example, has grown far faster than the CPI-U and eats up a large chunk of the monthly budget of people today.

  25. Minimum Wage says:

    There’s something else to consider. (I haven’t waded through the comments; it wouldn’t surprise me if someone else has already mentioned this.)

    There is an opportunity cost of foregone investment with the 15 year loan. For the benefit of a shorter payoff, you’d be paying an extra $450 (approx) every month for the 15 year mortgage. That’s $5,400 per year you could be investing for the first 15 years. I haven’t done the math, but that amounts to a pile o’cash after 15 years of compounding. And at 4% annual inflation, the after-tax cost of 30 year mortgage money for someone in the 28% tax bracket is close to zero.

  26. Patrick says:

    This is a great way to think about a 15 yr vs. 30 yr. There are many other factors that need to be thought about as well. Someone mentioned that most people do not live in a house for the full 30 years, and many do not even live there for the full 15 years. A lot of people will never pay the house off because they move too often (or the only house the ever pay off will be their retirement home).

    Another big factor in determining a 15 yr. vs a 30 yr. is the size of the monthly mortgage payment. Yes, giving up extra money to interest over the course of the loan hurts, but for many people, so does an extra few hundred dollars per month. That amount keeps many people from buying a house.

    I don’t think there is a ‘one size fits all’ approach for many financial issues, and it can be dangerous to claim there is. The best thing to do is research each case on its own merits and make the best financial decision for those circumstances.

  27. boardmadd says:

    Another option that I would suggest to help this out as well. Have a 30 year mortgage and pay it off as though it were a fifiteen if you can afford to do so. If you pay your loan off early, keep making the same house payment you were making for the remainder of the loan and place itin an index fun or other high yield investment. At the end of your 30 year fixed loans term period, check to see how much money you have made *for yourself* rather than paid out to the bank. this is the process we are in right now (30 year mortgage paid off in 10 years due to making a lump sum payment on the remainder of the mortgage), and now we are making our same house payment into savings and mutual funds. While the math may favor 15-year or 30-year loans one way or another, nothing beats the math of just doing everything you can to pay it off early and keep making the payment to *yourself*, IMHO :).

  28. Bewildered says:

    Why doesn’t he make an assumption of savings + interest (@ inflation or higher) of the money NOT being paid toward interest during the final 15 years? That number adds back into the savings.

    His analysis assumes *POOF*, all money disappears after you pay off the 15 yr mortgage.

  29. Bewildered says:

    Oh…not to mention earnings power @ earnings increases at rate of inflation, thus, assume your dollar is worth as much tomorrow as today.

    I submit you save EVEN MORE money than the original assumption.

  30. Debtfree says:

    This is an interesting thread. All this analysis misses the point that debt is debt, whether it is a mortgage payment or a payment on a car loan, you still have to make the payment every month. If you can afford it, pay cash for a car, and if you have the money, pay cash for a house. If you want to leverage yourself and invest money, then effectively you are investing on the margin, which is fine if you want to take on the risk. Ironically, many people today don’t even bother with a 30yr mortgage and just go for interest only to keep the monthly expenses down. This is like a credit card that is never paid off.

    If you pay off debt completely, it lowers your monthly overhead and you can live on less income, or if you maintain the same income you can spend more or save more. Paying off debt early is not just piece of mind. It is weird how it has become common sense that certain debt, like a mortgage or student loans, are good debt. They are easier to deal with than short-term credit card debt, but ask anyone with student loans if the debt is “good.”

  31. John says:

    The key thing about mortgage is the Principal amount. If is within your means, 15 or 30 years mortgage payment make not much different in interest payment, if you have other investment in stock and bond instead of use it to pay the mortgage. Moreover, a house is no an investment like a plot of land or gold, it is a manufactured good that value goes down if over supply and there is wear and tear. The economic situation of past can not be reliable for future prediction, because the economy structure has changed.

  32. Chris @ BuildMyBudget says:

    To debtfree, ask anyone with student loans and I bet they will say that their education opened many doors that wouldn’t have opened otherwise. Some debt is good debt if it increases your earning power and ability to improve your quality of life.

  33. Joe says:

    After the 15 year loan is done, start throwing that payment into savings. If you get the same 5.91% rate, you’ll have $488,331.21 in 15 years!!!!! If you get 8%, perhaps a more realistic return, you’ll have $586,201.15. Hands down, a better decision.

  34. Jack says:

    If the inflation is at 4% for the next 30 years, only the amount of the original value of the loan is affected. This year I’m paying with a full dollar, but next year it’s only .96 cents. But next year I’m paying with a 2011 dollar not a 2010 dollar. Ones salary (hopefully) inflates about the same 4% a year. Ones payment freezes at the respected montly payments, but you should have extra dollars to spend or invest after 15 and 30 years.

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