15-Year vs. 30-Year Mortgage
Two 35-year-old men buy a home and take a mortgage. Both get prices for a 15-year and 30-year mortgage. One takes a 15-year mortgage. Then, when the home is paid off, he puts the amount of the mortgage payment into a retirement account each month. The other decides to make the same total payment as the 15 year mortgage, putting the cost savings each month into a retirement account.
At age 65, one has $1.17 million in his retirement account and the other has $791,000. Which one is the millionaire?
It's the person with the 30 year mortgage!!
How can that be? The interest rate for a 15-year mortgage is lower than for a 30-year mortgage, and the loan is paid off in half the time. This saves the homeowner thousands of dollars in interest over the life of the mortgage.
These savings have made the 15-year mortgage increasingly popular, especially among higher-income homeowners. And as it turns out, they are the people who can realize the greatest benefit from an alternate strategy.
"Individuals should not attempt to analyze mortgage decisions in isolation from their overall personal financial plan," Decisions should be made within context of plans for long-term investing, insurance needs, tax planning and so forth.
In this example, the following assumptions were used: a mortgage of $150,000, a combined federal and state tax bracket of 33 percent, a 15-year mortgage at 7.5% and a 30-year mortgage at 8% and a 10% return on the retirement savings.
Under the 30-year mortgage scenario, buyer immediately begins investing in his retirement plan the cost savings between the higher payments of the 15-year mortgage and the lower payments of the 30-year mortgage.
The result is that the homeowner with the 30-year mortgage builds a retirement account worth $1.17 million. The owner paying off the mortgage in 15 years builds a retirement account worth only $791,000.
"The benefits of 30-year mortgage are the greatest for home buyers in high tax brackets buying relatively expensive homes. Yet these are homebuyers most apt to take out 15-year mortgages.
In summary, the 30-year strategy works best when:
- The buyer has the ability to make the higher 15-year mortgage payments.
- The buyer has the willpower to invest the difference.
- The buyer invests in assets, such as stocks, whose returns average higher than the mortgage rate over the long term.
- The buyer is in a high tax bracket.
- The buyer holds the home for the long-term.
- Mortgage rates are relatively low.
- The spread between the 15-year and 30-year mortgage rates is relatively small.
Homebuyers in lower tax brackets that invest conservatively wont fare as well under the 30-year mortgage scenario. They may actually benefit more from a 15-year mortgage if they can comfortably afford the higher monthly payments.
