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Why choose a 15-Year over 30-Year Fixed Rate Mortgage?

by retirebyforty on September 3, 2012 · 38 comments

in investing, real estate

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Last week, Savvy Financial Latina asked why we chose a 15 year Fixed Rate Mortgage (FRM) when we purchased our first home in 2000. There are many reasons why we picked the 15-year mortgage, but the most important factor was that we could afford it. We were both making reasonable incomes and the house was more affordable back then. There were also other reasons to go with the shorter term.

  • We could build equity faster;
  • We would pay much less interest compare to a 30-year loan. The 15-year loan also had a lower interest rate;
  • We would own the home sooner;
  • We did not have much debt so it wasn’t a big problem to make the payments. We only had a small car loan at the time and no other debts;
  • The interest rate was much higher in 2000. I think we got the 15-year loan with the rate of around 8%. The higher rate meant we would have paid a lot more overall if we went with the 30-year fixed rate mortgage.

Let’s crank some numbers.

The home value at the time of purchase was $210,000.

We put down 20% to avoid PMI so the loan amount was $168,000.

15 year (circa 2000) 30 year (circa 2000)
Interest rate 8% 8.5%
Monthly payment $1,605 $1,292
Total interest $120,989 $297,039
Total payment $288,989 $465,039

 

If we had gone with the 30-year mortgage, we would have paid $175,050 more in interest. That is more than how much we borrowed in the first place ($168,000.) The payment for the 30 year FRM was around $300 lower, but we didn’t think that was worth the extra 15 years. We were willing to sacrifice $300 in spending money to own the home 15 years faster. It was pretty easy to decide to go with the 15-year FRM because we could afford to do it. If we had more debt, it might have been a more difficult decision.

Now, a more interesting question is would I do the same thing in 2012?

Let’s add a couple of columns to our table.

15 year (circa 2000) 30 year (circa 2000) 15 year (2012) 30 year (2012)
Interest rate 8% 8.5% 3% 3.5%
Monthly payment $1,605 $1,292 $1,160 $754
Total interest $120,989 $297,039 $40,832 $103,582
Total payment $288,989 $465,039 $208,832 $271,582

The interest rate dropped tremendously since the year 2000 and we can see it makes a huge difference in both the monthly payment and the total interest.

With today’s interest rate, we would pay less interest on the 30-year FRM than our original 15-year term. That’s pretty interesting isn’t it? The low interest rate also makes it much more affordable to own a home. I think this is a great time to buy a house if you can afford the payment.

30 and 15 year fixed rate mortgage history

We probably would still choose the 15-year FRM if we were in the same situation today. If you can comfortably afford it, the 15 year mortgage is the way to go. On the other hand many people have one of more of these: student loans, car loan, credit card debt, alimony payment, health issues, small emergency fund, or other debts. If that’s the case for you, then it will be more prudent to go with the 30 year mortgage. It will give you more flexibility and you can make extra payments when you can.

The downside to going with 30 year FRM and making extra payments is that most people can’t stick with it. There will always be more things to spend money on and it’s difficult to send in the extra payment every month.

Current status of our first home:

We refinanced this home a few times to take advantage of subsequent lower rates. This home is a cash flow positive rental at this time and I’m not making any extra payments.

Amount owed: $80,000

Mortgage term: 10 year FRM @ 3.875%

Monthly payment: $1,000

Pay off date: 2021

It is good to refinance the rental home to take advantage of lower rates, but the pay off date reset, so it takes longer to own the home. It would be crazy to stick with the original 8% interest rate though. Have you taken a look at the latest interest rate lately? The rate is amazing and it might be time to refinance. Give  Quicken Loans a call. They are fast and can get everything done very quickly. The downside is some of their sales people like to use high pressure tactics so be ready for that. That’s what I heard. The guy I dealt with was pretty reasonable and didn’t pressure me that much.

quicken loans refinance

Disclosure: I receive a referral fee if you refinance with Quicken Loans through the links on this page.

 

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{ 36 comments… read them below or add one }

Terry September 3, 2012 at 1:01 am

I can’t buy a house, so I’m stuck paying inflated (and rising) rent indefinitely, which means I’ll probably never be able to retire.

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retirebyforty September 3, 2012 at 6:07 pm

Sorry to hear that. It sounds like you need to grow your income. You can do this with further education or growing a business on the side. Don’t give up, there are many things you can do.

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traineeinvestor September 3, 2012 at 2:04 am

Hi

With respect, while I agree with the conclusion that the 15 year loan was better than the 30 year loan, the savings are probably a little overstated becuase the difference in payments would presumably be invested elsewhere. Then again, for people with a poor self discipline (obviously not you) , it would probably have been spent.

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retirebyforty September 3, 2012 at 6:09 pm

I agree. It’s great if you can invest the difference, but most people can’t control their expense when they have extra money in the bank.

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TM @ Young and Thrifty September 4, 2012 at 6:17 pm

I’m in the “invest wins vs paying all-time low interest rates” crowd as well Joe. Obviously you couldn’t have predicted what interest rates were going to do back then, but as of today, I wouldn’t advise anyone to rush to pay down their house. I would definitely max out my registered contribution capacity before making larger payments on my mortgage. Granted, my overall mortgage and mortgage-to-income ration is much smaller than most people’s, but the principle remains the same. I do hear you though on the idea of forced savings for people who are financially illiterate.

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Another Reader September 3, 2012 at 5:24 am

There are less expensive and better places to borrow than Quicken Loans. Comparison shop with a good mortgage broker and check your local credit unions. Anyone in the mortgage business employing high pressure sales tactics should be avoided.

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retirebyforty September 3, 2012 at 6:10 pm

The guy I talked to didn’t pressure me that hard so it might just be a specific salesperson.

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Edward Antrobus September 3, 2012 at 6:05 am

I don’t know if this was the question that LaTisha was after or not, but another question would be why not get the 30 year and pay it off in 15?

Obviously since you are nearing the payoff date, it hasn’t been an issue for you, but I believe the reason that many people go with a 30 year term when they can afford the higher payment of a shorter term is for the piece of mind in case their income every dropped substantially.

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retirebyforty September 3, 2012 at 6:13 pm

That’s a good move, but most people can’t stick to paying extras every month. I started paying extra on various mortgages, but inevitably failed to keep doing it.

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Kurt @ Money Counselor September 3, 2012 at 6:55 am

I like Edward’s idea: Sign up for a 30-year mortgage, and, if doing so fits your budget, make payments according to a 15-year payoff schedule. The negative is that the interest rate will be a bit higher on a 30-year vs. a 15-year. The positive is flexibility. If you really needed to–say in the event of a layoff or maybe one of two income earners wants to take a year off to go to school–you could revert to the 30-year payment for a while without risking foreclosure. I look at the higher interest rate on the 30-year as a premium for “flexibility insurance.”

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Lance @ Money Life and More September 3, 2012 at 8:42 am

I like the 30 year better right now because I believe in the next 30 years there will become a time when savings accounts are paying more in interest than I’m paying on my mortgage and inflation will make it a good long term decision for me. We’ll see how it works out. I plan on renting out this house whenever we decide to move into a larger home when we start a family.

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retirebyforty September 3, 2012 at 6:17 pm

I like the 30 year FRM right now too. The rate is so low.

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Michelle @ See Debt Run September 3, 2012 at 10:15 am

My post today is about the insane amt of money we’ll be saving by simply switching to a 15-year loan! Great stuff, RB40!

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krantcents September 3, 2012 at 12:29 pm

I chose the 15 year mortgage when I refinanced roughly 9-10 years ago. My main attraction was the lower interest rate because the payment difference was marginal (approx. $100). I could have taken the 30 year and just accelerated it, but it was a higher interest rate. I am investigating refinancing, but I have a small balance and many banks won’t do it. If I can refinance, I will choose the 5/1 ARM because I can maintain my payment and pay off the balance in less (approx. 4 months early) than 5 years.

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retirebyforty September 3, 2012 at 6:18 pm

You made a great decision 10 years ago. I hope you find a bank that can work with you. How about ING?

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Kim September 3, 2012 at 1:51 pm

We originally took out a 30 year loan in 2004 at 5.75%. We made an exta payment every year to build up a little more equity. We refinanced in 2009 to 4.5%, and changed to a 15 year term, thinking this is it and we will pay the sucker off. When interest rates kept falling, we refinanced again early this year and got a sweet 3.25% rate, but we didn’t want to add years and took a 13 year term. We are still making the extra payment and should be paid off in 2022. I think the term doesn’t necessarily matter as long as you have a good rate and aren’t losing more than you have to for interest. I would never take out a 30 year loan for a primary residence unless I was going to make extra payments. I don’t want a mortgage in my 60’s. However, a business colleague of mine who is in his mid 60’s recently refinanced at a 30 year term, not ever intending to pay off his house. He’ll let the bank take it when he dies, I guess. He wanted more money for now. Seems odd ,but whatever your motivation is, take advantage of the interest rates while they are low.

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retirebyforty September 3, 2012 at 6:21 pm

Thanks for sharing. I think when people are in retirement, they are more concerned about the monthly cash flow. That’s the main reason why we have a 30 year FRM with our current residence. We are making extra payments, but have the flexibility to cut back if I don’t make as much money as projected.

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Roshawn @ Watson Inc September 3, 2012 at 2:02 pm

We had a 30-year fixed that we paid like a 15-year mortgage. I got the mortgage before I knew better. It is a personal decision, but I can say that I am VERY happy that we paid it like a 15-year mortgage, particularly when it came time to sell the property.

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retirebyforty September 3, 2012 at 6:22 pm

Great job! Hopefully the housing market recovers before you sell the place. :)

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SavvyFinancialLatina September 3, 2012 at 2:07 pm

Thanks for answering my question!!!

When I’m ready to buy a house, I think I would go for the 15 year term loan. Frankly, 30 years seems like an awfully long time in order for you to own your home. Might as well, stay living in an apartment…

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retirebyforty September 3, 2012 at 6:22 pm

Housing is very affordable in Texas and I’m sure you can do it. Good luck!

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donny September 4, 2012 at 12:47 am

So u still have 9 years left and owe 80k. payed for 12 already so a 21 year mortgage. sounds like u should have lwered ur time to match up better and only have 3 years left and rental income coming straight to you???

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retirebyforty September 4, 2012 at 7:58 am

Yes, I made some mistakes and refinanced too many time over the years. It would be nice to have the check coming straight to me. As long as the rental is cash flow positive, it’s good. Having positive cash flow is a big deal for me because I don’t have to work another job to supplement the rental.

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SMB September 4, 2012 at 5:32 am

We went with the 30 year FRM mostly because the area we live in (DC) is extremely expensive. We could only afford the type of house where we didn’t feel like we’d want to move as soon as we started having kids with the 30 year. I’m sure it’s not the most fiscally responsible decision I’ve ever made, but I think it makes some sense. We could have found something cheaper that we could have afforded a 15 year on, but I really think we would have wound up moving earlier. Also, I agree with Lance, I’m not really in a rush to pay it off because I believe future investments (and even some now) will make me more than my mortgage is costing me.

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retirebyforty September 4, 2012 at 2:27 pm

That’s the right choice for you. If you can’t comfortably afford the 15 year FRM then it’s better to go with the 30 year FRM.

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Mike September 4, 2012 at 5:42 am

I’m not at the point where I can afford a house yet but I think it’s good to have posts like this overviewing some of the differences in mortgages. It’s simply something that I didn’t get in school or even from parents.

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retirebyforty September 4, 2012 at 2:28 pm

Thanks! Good luck in the future.

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Jeff @ Sustainable Life Blog September 4, 2012 at 8:28 am

Joe –
those were basically the same reasons that H and I went with a 15 year note. We could comfortably afford it, build equity faster and would pay it off sooner – even if 1 of us was not working full time at some point during the length of the note.
It will also help hugely when children are in the picture – the house will be paid off no matter what (unless we refi, doubtful at our rate of 3.375) when they are in high school.

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retirebyforty September 4, 2012 at 2:29 pm

That’s great to hear. Looking forward to meet you in Denver. :)

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Nate September 4, 2012 at 11:04 am

Question:
I am about to buy a house and I want to get it paid off ASAP.
Having a mortgage brings a serious tax cut.

When does the benefit of the mortgage tax break outweigh the benefits of less money paid in interest on a 15 year loan? This will vary subject to tax bracket and interest rate but leads me to think that perhaps neither a 15 or 30 year loan will maximize Net savings.

How can I determine how quickly to pay off a 30 year loan to maximize the tax cut that comes with a mortgage?

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retirebyforty September 4, 2012 at 2:35 pm

The tax cut is nice, but I don’t think it’s comparable to how much money you’ll save in the long run with a 15 year FRM. If you look at the table above, you can see that the 15 year FRM will save you over $60,000 in interest. The tax break won’t add up to $60,000 no matter how you cut it.
Don’t worry about the tax break, that’s letting the tail wag the dog. (That’s what I read recently…)
The next time you do tax, you can try adding interest and see how much you really get back.

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Kathleen @ Frugal Portland September 4, 2012 at 1:04 pm

HOLY COW that’s a lot of interest saved! If I decide to own my home, I will only do it with a 15-year note.

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retirebyforty September 4, 2012 at 2:35 pm

Good luck! Housing price is not bad in Portland right now.

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Ruth September 4, 2012 at 4:01 pm

If you are the type of person who could save the extra $300/mo and invest it, though, and you psychologically don’t mind having a mortgage for 30 years, it is also a good decision to go with the longer time frame. $3600/year for 30 years at 3% nets you over $200k, if I filled out the compound interest calculator right, which is more than you save on interest. (It’s quite possible I’m doing some math wrong, though, so feel free to correct me.)

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Ruth September 4, 2012 at 4:03 pm

Oops–I meant at 4%. Which seems doable.

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Ces @ Filamwords.com September 11, 2012 at 7:44 pm

15 year is really an attractive mortgage for those who can afford it the monthly payment. The interest rate is lower compared to the 30 year counterpart and yes you can build equity faster as well.

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