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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