15 vs 30 Year Mortgage - Which Should You Choose?

How to compare the mortgages to choose what is right for you

There are 2 main fixed rate mortgage types 1) 30-year fixed rate or 2) 15-year fixed rate. Personal Finance gooroos are big fans of 15-year mortgages to pay down your mortgage faster on your path to being debt free. However, is that the best choice?

What are the trade-offs between a 15-yr vs 30-yr mortgage?

Which is right for you?

And more importantly, how can you analyze the choice yourself?

[Note - Yes I am aware of ARMs and other mortgage types. They are less popular for the main residential home & I would not want any sort of variable rate during a rising rate environment. So for the purpose of this comparison, less popular residential mortgages are ignored]

The Argument for a 15-Year Mortgage

You pay less interest and you pay off your mortgage faster.

By paying higher payments, you are paying off the principal of the loan quicker. This results in a smaller principal balance and a lower loan balance multiplied by the interest rate means less interest paid. If you pay a 4% loan over 15-year or 30-years, you pay over twice as much interest over the 30-years.

However, 15-year mortgages will likely also have a lower overall interest rate. If your 30-year loan has a 4% rate, a 15-year mortgage could be a lower rate like 3.5%. This will further decrease the interest you pay.

When you compare a 15-year vs a 30-year mortgage the results are pretty stark. Below is an example showing the total interest and principal payments on a $240k mortgage for a 15-year at 3.5% and a 30-year at 4%:

Taken directly from Dave Ramsey’s site. This is for a $240,000 loan amount and a 3.5% rate on the 15 year mortgage & 4.0% rate on the 30 year.

With a 30-year mortgage your interest payment is $172k on a $240k borrowed amount vs only $69,000 (nice) on a 15-year mortgage. So you pay almost 2.5x more in total interest under a 30-year than a 15 year. Here it is in the table form

Also from Dave Ramsey’s site - You can go and find how he discusses this. I refuse to link to his site, but if you read his article you can easily compare numbers vs here

Right-Sizing Your Home Purchase

The other positive thing about a 15-yr mortgage, is it will prevent people from over-extending to purchase a home they really can’t afford.

The general rule of thumb is 25-30% of your income can be spent on your mortgage. How many people actually follow that rule? Anecdotally, not many.

Using the 25% rule and a 15-yr mortgage payment, someone would need to make ~$82k after-tax to take out the $240k mortgage. ( =$1,716 / .25 * 12 = $82k after-tax income).

However, the same 25% rule and a 30-yr mortgage payment says someone could take the $240k mortgage on ~$55k income. If someone with a $55k income looked at the 15yr mortgage, it would be ~37% of their after-tax income (=($1,716 * 12) / $55,000).

The absolute numbers aren’t important here since most people way overextend on their homes. But relatively speaking, a 30-year mortgage allows for buying a home about 50% more expensive than a 15-yr mortgage does.

The important point is that by looking at the 15-yr mortgage payment, people are less likely to buy too much home. (Counterpoint to this later)

You can avoid over-extending by pretending you were making a 15-year payment to calculate your budget. Then regardless if you get a 30 or 15 year mortgage you will buy a more ‘reasonable’ home for your budget.

The Argument for a 30-Year Mortgage

Allright, so you are paying more interest, what is the case for the 30-year mortgage?

Opportunity costs & Optionality/Flexibility.

Both are related to not locking yourself up in the higher monthly payment of a 15-year mortgage. In the table above you see a 15yr mortgage is $1,716 a month payment vs $1,146 a month for a 30yr mortgage. That is an extra $570 a month you are forcing yourself to have to pay.

So yes, you get a 50bps lower mortgage rate, BUT you are requiring yourself to pay a higher payment each month.

The other reason - you get to purchase more home.

Get To Purchase A Larger Home

Wait…I thought you said the benefit of a 15-yr mortgage is it keeps your from buying a big house…but now the benefit of a 30 year is it allows you to buy a big house? How does that make sense?

This is a counterpoint to one of the benefits of a 15-yr mortgage (if you budget for a 15 year mortgage, you will buy a less expensive home).

Historically, home prices go up and most of the wealth the middle class accumulates is due to their home.

You could make an argument that being reasonably over-extended on your home is a good financial decision as:

• As your salary should increase, it becomes easier to pay for (financially grow into the house)

• The $ amount of appreciation may be larger for a more expensive house:

  • Rough maths - A $100k vs $200k home. Market goes up 10%. The $100k home gained $10k in equity, the $200k home gained $20k. The $ of appreciation is larger for the larger value even if the % growth is the same. (although no guarantee the % growth is the same across all house brackets)

• If you buy a small ‘starter’ home and then have to move, there is a cost in time & actual money to move to a larger house

This does not mean you go buy way more house than you can afford. F’er isn’t telling you to buy that mega-mansion on your $50k salary to ‘grow into it’.

Not a reasonable purchase no matter if you are a few months away from 3rd line shift manager at McDs or not.

But, over the life of the home ownership, being slightly extended at the start may be beneficial.

The Opportunity Cost of Shorter Mortgages

Opportunity cost is the unseen & intangible expense of the ‘next best option’ that you skipped in order to make your choice. It is hard to quantify. However, by ignoring the opportunity cost of your decisions you won’t know if you are actually making good decisions.

For example, you have 2 investment choices and you choose option A. A goes up 20% in a year. It seems like you made the correct choice. But if B went up 50%, then your opportunity cost is negative.

(If you want more details on opportunity costs, see the full post on them here)

The opportunity cost of selecting a 15-year mortgage is all the future potential things you can do with that additional payment. In the example above it is a $570 difference.

If you choose the 30-year mortgage, that $570 doesn’t disappear. However, it is conveniently left out of gooroos examples. Note Davey Boy Ramsey compares 15 years of payments vs 30 years of payments to show a big bad guy. But there is no mention of what you do with the additional $570 a month.

[Note - Now, full disclosure, if you are [redacted] and use it to buy consumable goods…you are probably better off getting a 15yr mortgage. You need to pay the ‘irresponsible behavior’ tax for being a child.

I assume this audience is looking to build wealth, and would invest that $570 instead.]

If you think that over the same 15 year period of time you have an opportunity to earn >4% annualized returns, you are better off investing that $570 elsewhere.

Paying $570 a month is an additional $102,600 over 15 years ( = $570 x 180 months). If you could earn a 6% return on each of those monthly payments, you would have almost $166,000 in an investment account 15 years later.

However, your outstanding balance on a 30-year at that point in time would be approximately $155,500. In this theoretical example, where you could earn 6%, you would be able to:

• Invest the $570 a month every month

• It grows to $166,000

• Pay off your $155,500 remaining mortgage

• In this scenario, at the end of 15 years you have no mortgage left regardless if you chose the 15yr mortgage and paid it off gradual OR the 30yr mortgage, invested the difference, and lump paid off your mortgage balance at year 15.

• BUT, you pocket a $10,500 gain by investing the difference and earning a 6% return

  • This $10,500 is your theoretical opportunity cost of choosing to pay a 15-year mortgage instead of a 30-year and investing the difference

The $10k opportunity cost is theoretical cost of the 15-year mortgage. (No wonder the gooroos ‘forget’ to talk about the $570 in payments).

The different ending value of an investment account growing at 6% if you invest the $570 difference in payments for 30 yrs or wait till year 15 when you pay off mortgage and then invest the full $1,700

The above exhibit shows the difference in 2 choices:

• Pay the 30-year mortgage and invest the $570 every month for 30 years at a 6% return

• Pay off the 15-year mortgage and then in month 181 start investing the full $1,716

The end result is almost a $75,000 difference in favor of the 30-year mortgage.

Now, if your return is less than 4% over the 15 years you would be better paying choosing the 15-year mortgage.

Maybe you like the sure thing of a 3.5-4% return. That is a perfectly fine choice - especially now since you are aware of your option.

Increased Optionality / Flexibility with a 30-Year

There is value in having options.

It is one of the reasons you want an emergency fund and lots of cashflow. Optionality is also the reason that mortgage points rarely make sense to pay. It gives you options for any unexpected costs or opportunities that arise.

Locking yourself into a higher payment removes flexibility and options.

Do a quick thought experiment - an unexpected cost comes up and you burn through your emergency funds.

• If you have the 15-year mortgage, you have little flexibility - You have a $1,700 payment every month.

• If you have a 30-year mortgage that you were investing the difference, your required payment is only $1,1000 a month. You now have an ‘extra’ $570 of cashflow available to you every month if needed.

[Note - yes you could always look to refi the 15-yr at the point in time you need flexibility but:

1. It is a headache to deal with a refi, especially if you have other issues going on that are taking time & energy & money

2. Who knows what the rates will be - you don’t want to be stuck taking a much higher market rate on your mortgage because you were forced to ]

Or, what if a great investment opportunity comes along?

If interest rates go up, you may be able to purchase ‘low risk’ assets at APRs higher than your mortgage. It isn’t unfeasible to see 5%+ rates on CDs and US Treasuries again. Savings accounts used to have 3%+ rates on them. If you lock in a 15-yr mortgage, you may miss being able to pivot into these opportunities in the future.

[F’er has a 2.75% rate on a 30-yr mortgage. My dream is to have the ability to buy a CD from my bank at a rate much higher than 2.75%. Let’s say 10yrs from now when my mortgage has 20yrs left on it, market rates are much higher. I can go to my bank and get CDs ranging from a 3% rate on a 1yr CD to a 20yr CD for 5.5%. You could purchase a CD ladder to completely pay off your mortgage at a discount to your loan balance.

Then I could call the bank and inform them that they are paying me money to be fully hedged and try to convince them to buy me out of my mortgage. ]

If only there was a way left open the flexibility of a 30-year mortgage while allowing those of you who want to pay down a mortgage faster to do so….

The 90s were great. Producers just did a bunch of blow and threw darts at a board of “Action Stars”, “Obscure Hobbies”, “Type of Terrorist” and would result in an action movie.

Cliffhanger for Part 2 of the series “How to own your home Without Opting for a 15-year Mortgage….

Summary: 15-Year vs 30-Year Mortgages

“So F’er its super clear that only dopes get a 15-year mortgage” you may be saying at this point….

I have a strong opinion that the 30-year is better. I have a 30-year fixed rate mortgage. I have no plans to ever pay 1 excess payment to it. I am confident that over any medium to long-term time frame I can outperform my mortgage APR with investments. Therefore, the opportunity cost of making extra payments isn’t worth it for me.

However, that doesn’t mean that my strategy is right for everyone:

1. If you are an irresponsible child who is going to spend and not save the difference - a 15-year mortgage will force you to be responsible and is a good choice

2. If you have a lot of cashflow and investments already and are viewing your home purchase as a way to diversify and the mortgage is immaterial to your budget - a 15-year is a simple way to do it

3. If you don’t think you can out-earn your mortgage rate.

   • Rates were sub-3% for a while which makes for a fairly low bar. If rates return to 6%, 8%, or higher, it changes the calculation. You need to update your rules for the world.

These are a few of the many possible reasons to opt for a 15-year mortgage instead of a 30-year.

This post should have laid some of the foundational math & concepts behind comparing a 15-year mortgage to a 30-year mortgage. When you are looking to get a house, you should atleast have some intuition about the trade-offs in the decision.

Part 2 will show two alternative strategies that may be an even better option for you.