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I've found similar questions, but they all seem to focus on a preexisting 30 year mortgage and whether or not it makes sense to refinance to a 15. My question is a bit different. I have not yet bought a house but I am trying to decide which mortgage to go with. As a result, I don't have to consider refinance fees and a change in interest rate.

The situation is that I can afford the payment on a 15 year mortgage and would prefer not to pay off a house for the next 30 years. So I was going to go with a 15. However, in looking at some mortgage calculators (which it is possible I am looking at incorrectly) it seems that there is no difference in getting a 30 year mortgage and just paying it off in 15 years. The calculators seem to say that--assuming the same interest rate--you will pay the exact same interest over 15 years.

As a result, my thinking is, I can get the 30 and pay it like a 15. If there really is no drawback then this gives me the ability to pay the normal 30 year payment if needed due to financial hardship (loss of employment etc.)

So my question is, am I missing something? If not, why would anyone ever get a 15 year instead of just paying off a 30 year in 15 years?

In summary: Does it really cost the same amount of money overall to pay off a 15 year mortgage vs paying off a 30 year mortgage in 15 years?

PS: Please don't suggest taking the 30 year and investing the extra money. I know this is an option and the one many would suggest. However, for the purposes of this question please only consider 15 year vs 30 year paid off in 15.

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    Intentions are great aren't they? However, 100% of 15 year mortgages that are paid off are paid off in 15 years or less. Not so with 30 year, regardless of intentions. – AbraCadaver Jan 13 '15 at 21:34
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    No, there are 15 year mortgages that are never paid off at all! – Rice Flour Cookies Jan 14 '15 at 1:34
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    But he did specify "...of 15 year mortgages that are paid off are paid off in...". Probably still not quite correct, since I'm sure a few mortgages are paid off late (with late fees goading you to not be too late!), or something else that may not qualify (e.g. refinanced). – Tim S. Jan 14 '15 at 15:37
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    @RiceFlourCookies: As Tim pointed out I qualified my statement. Additionally, your required payment will be lower for a 30 year so you may qualify for a more expensive home. – AbraCadaver Jan 14 '15 at 16:17
  • I have done both. 30 year is more flexible. As someone with some cash flow issues in the past, the 30 year mortgage is better. From a financial perspective, the 30 year mortgage sucks moose nuts. – ssaltman Mar 9 '15 at 14:36

11 Answers 11

102

Your calculations are correct if you use the same mortgage rate for both the 15 and 30 year mortgages. However, generally when you apply for a 15 year mortgage the interest rate is significantly less than the 30 year rate. The rate is lower for a number of reasons but mainly there is less risk for the bank on a 15 year payoff plan.

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    This. I went with a 15 year, and got about .35 points lower rate than I would have with a 30 year (something like 3.25 vs 3.6 at the time). You're paying a penalty in exchange for the flexibility to pay less when you need to; you're welcome to do so, if you're willing to pay that penalty. – Joe Jan 13 '15 at 20:28
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    I should add that a .35 points does not seem like a large number if you enter it into the mortgage calculator that you are using the saving over all those years is rather large. – rhaskett Jan 13 '15 at 20:49
  • Actually, dropping a 30-year mortgage from 3.60% to 3.25% would only allow you to increase the principal by about 4.5 % for the same payment schedule... – DJohnM Jan 14 '15 at 5:42
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    ... so instead of buying a house for $200,000 you could buy a house for $200,000 and put $9,000 in your pocket for the same payment schedule. Not bad. – gnasher729 Jan 14 '15 at 16:24
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    If the interest rate were the same either way, I would choose the 30 since it gives me that flexibility, like you said, to slow down due to financial hardship. If the interest rate is lower for a 15-year mortgage, which it usually is, then I would choose the 15 because it saves money on interest. – Brandon Jan 15 '15 at 2:21
28

"Why would anyone ever get a 15 year instead of just paying off a 30 year in 15 years?

Because the rate is not the same. Never that I've seen in my 30 years of following rates. I've seen the rate difference range from .25% to .75%. (In March '15, the average rate in my area is 30yr 3.75% / 15yr 3.00%) For a $150K loan, this puts the 15yr payment at $1036, with the 30 (at higher rate) paid in 15 years at $1091. This $55 difference can be considered a "flexibility premium," as it offers the option to pay the actual $695 in any period the money is needed elsewhere.

If the rate were the same, I'd grab the 30, and since I can't say "invest the difference," I'd say to pay at a pace to go 15, unless you had a cash flow situation. A spouse out of work. An emergency that you funded with a high interest rate loan, etc. The advice to have an emergency fund is great until for whatever reason, there's just not enough.

On a personal note, I did go with the 15 year mortgage for our last refinance. I was nearing 50 at the time, and it seemed prudent to aim for a mortgage free retirement.

13

If the interest rate in both mortgages is the same, then yes, you will end up paying the same amount in interest if both are paid off in 15 years.

However, in practice, almost always a 15-year mortgage will have a much lower interest rate that a 30-year mortgage.

Also, if you are thinking of taking out a 30-year mortgage with the intention of paying it off early, make sure it does not have an early payment penalty; this is a penalty the bank will charge you if you pay back the loan early.

12

Yes. It does cost the same to pay off a "15 year in 15" year versus a "30 year in 15 year" mortgage. After all, the 30 year amortization period is only used by the lender to calculate the monthly payment he'll expect, while, unbeknownst to him, you are using a 15 year amortization and the same rate to calculate the payments you'll really make.

One factor: Can you make extra payments at the level you want, without incurring penalties from the lender? Most mortgages have prepayment limits. After all. he's seeing his nice steady 30 years of cash flow suddenly shortened. He has to go out and find someone else to lend the unexpected payments to...

EDIT: Closed mortgages, with pre-payment charges are the norm here in Canada; open mortgages predominate in the US

http://www.cmhc-schl.gc.ca/en/corp/nero/jufa/jufa_018.cfm

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    Not really true, since 15 year mortgages almost always have lower interest rates – Hilmar Jan 14 '15 at 15:44
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    Most mortgages have prepayment limits. After all. he's seeing his nice steady 30 years of cash flow suddenly shortened. I've always thought that was a bogus excuse. Yes, the income flow is gone, but the principal has been returned (with some interest) well ahead of schedule, and can now be reinvested much earlier than was originally planned, so it all balances out. – Mason Wheeler Jan 14 '15 at 21:34
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    @MHH: Theoretically, sure, but what reason would such a customer have to do it that way? If I had the intention of paying the full value of something immediately, why would I want to secure a loan in the first place? The only possible motivation I can think of is straight-up trolling, and most trolls can't afford to pay cash for a house. :P – Mason Wheeler Jan 16 '15 at 0:13
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    @MHH It seems unlikely that they'd really lose money since they seem to collect at least some one-time fees (and sometimes a lot of one-time fees) at the time of origination of the loan. In fact, this is to the extent that many people writing mortgages do so with the intent to immediately sell the mortgage to, say, Fannie Mae, without ever collecting the first payment. Of course, this writing of mortgages without concern for the person actually paying it back later is also part of what brought us the recent financial crisis. – reirab Jan 16 '15 at 19:13
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    @MasonWheeler I'm assuming a fixed rate mortgage. If market interest rates decrease, then that makes other investments less attractive, so the homeowner might as well "invest" in prepaying the mortgage loan instead, which now seems more attractive by comparison. (Using, say, $10k to prepay the loan is similar to buying a $10k bond at the original rate, which becomes more attractive if it is higher than the current market rate.) – Trevor Wilson Jan 17 '15 at 2:49
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All of the answers given so far are correct, but rather narrow.

When you buy a 30-year-mortgage, you are buying the right to pay off the debt in as long as 30 years. What you pay depends on the interest rate and how long you actually take to pay it off (and principal and points and so on).

Just as you are buying that right, the mortgager is selling you that right, and they usually charge something for it, typically a higher rate. After all, they, and not you, will be exposed to interest risk for 30 years.

However, if some bank has an aneurism and is willing to give you a 30-year loan for the same price as or lower than any other bank is willing to go for a 15-year loan, hey, free flexibility. Might as well take it. If you want to pay the loan off in 15 year, or 10 or 20, you can go ahead and do so.

  • Welcome to Money.SE. Yes, the answers are narrow, because the question was phrased in a way that made them so. The OP specified what to avoid in one's answer. – JoeTaxpayer Jan 17 '15 at 0:32
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Besides the reason in @rhaskett's answer, it is important to consider that paying off a 30-year mortgage as if it was a 15-year is much more inconvenient than just paying the regular payments of a 15-year mortgage. When you pay extra on your mortgage, some lenders do not know what to do with the extra payment, and need to be told explicitly that the extra needs to be applied toward the principal. You might need to do this every month with every payment. In addition, some lenders won't allow you to set up an automatic payment for more than the mortgage payment, so you might need to explicitly submit your payment with instructions for the lender each month, and then follow up each month to make sure that your payment was credited properly. Some lenders are better about this type of thing than others, and you won't really know how much of a hassle it will be with your lender until you start making payments.

If you intend to pay it off in 15 years, then just get the 15-year mortgage.

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    Unless you are unsure of really being able to sustain the extra payments. See variable income. – Joshua Jan 13 '15 at 22:17
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    I never understand why this is a problem for lenders (not arguing it isn't, just that it makes no sense). If I owe $2000 a month, and send in $3000, credit the extra $1000 and don't complain about it. If I send in two checks on different days for $2000 each I would understand the potential, but one oversized check seems obvious. – Joe Jan 15 '15 at 15:14
  • @Joe Agreed. It's almost as if they miscredit the payments on purpose... – Ben Miller Jan 15 '15 at 17:06
  • @Joe I think in your example, the issue is whether you'd rather have the credit applied to your next payment, or the principal. It might not be as obvious as you think, so they tend to default to the one that favors them when there's no explicit instructions. – A.J. Brown Jan 15 '15 at 22:10
  • I think that the payment should be credited immediately to the account, whether or not it removes the obligation to make the next payment. I don't mind it working like student loans - where overpayment reduces the next payment automatically - as long as you're still allowed to make the next payment; but effectively holding on to the payment for most of a month without reducing the interest is wrong. – Joe Jan 15 '15 at 22:17
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Consider the "opportunity cost" of the extra repayment on a 15 year loan. If you owe money at 30% p.a. and money at 4% p.a. then it is a no brainer that the 30% loan gets paid down first. Consider too that if the mortgage is not tax deductable and you pay income tax, that you do not pay tax on money you "save". (i.e. in the extreme $1 saved is $2 earned).

Forward thinking is key, if you are paying for someone's college now, then you would want to pay out of an education plan for which contributions are tax deductable, money in, money out.

In my country most mortgages, be they 15,25,30 years tend to last 6-8 years for the lender. People move or flip or re-finance.

I would take the 15 for the interest rate but only if I could sustain the payments without hardship. Maybe a more modest home ?

If you cannot afford the higher repayments you are probably sailing a bit close to the wind anyway.

Another thing to consider is that tax benefits can be altered with the stroke of a pen, but you may still have to meet repayments.

0

Other people have belabored the point that you will get a better rate on a 15 year mortgage, typically around 1.25 % lower. The lower rate makes the 15 year mortgage financially wiser than paying a 30 year mortgage off in 15 years.

So go with the 15 year if your income is stable, you will never lose your job, your appliances never break, your vehicles never need major repairs, the pipes in your house never burst, you and your spouse never get sick, and you have no kids. Or if you do have kids, they happen to have good eyesight, straight teeth, they have no aspirations for college, don't play any expensive sports, and they will never ask for help paying the rent when they get older and move out.

But if any of those things are likely possibilities, the 30 year mortgage would give you some flexibility to cover short term cash shortages by reverting to your normal 30 year payment for a month or two. Now, the financially wise may balk at this because you are supposed to have enough cash in reserves to cover stuff like this, and that is good advice. But how many people struggle to maintain those reserves when they buy a new house?

Consider putting together spreadsheet and calculating the interest cost difference between the two strategies. How much more will the 30 year mortgage cost you in interest if you pay it off in 15 years? That amount equates to the cost of an insurance policy for dealing with an occasional cash shortage. Do you want to pay thousands in extra interest for that insurance? (it is pretty pricey insurance)

One strategy would be to go with the 30 year now, make the extra principal payments to keep you on a 15 year schedule, see how life goes, and refinance to a 15 year mortgage after a couple years if everything goes well and your cash reserves are strong. Unfortunately, rates are likely to rise over the next couple years, which makes this strategy less attractive. If at all possible, go with the 15 year so you lock in these near historic low rates. Consider buying less house or dropping back to the 30 year if you are worried that your cash reserves won't be able to handle life's little surprises.

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    I didn't see the rate difference belabored, only mentioned. It's critical to the discussion and shouldn't be ignored. Your second paragraph is a fair warning even if presented in the snarky manner you wrote it. It suggests that the downside of the 15 year is reduced liquidity, and I agree that warning isn't to be ignored. – JoeTaxpayer Mar 31 '15 at 17:38
0

I just wanted to point out that the most "leverage" for pre-paying occurs at the very beginning of the mortgage, and declines rapidly after that. So, your very best scenario is to get the 30-year, and make one extra payment entirely to principal the first month of every year. This causes the amortization to drop by 96 payments, to about 22 years. I don't know of any other way that you can get nearly 4 times value for your money (22 payments extra to save 96 payments later). After that, reducing from 22 to 15 years takes more of your money for the same result, but do it if you want.

I actually did this, and it put me way ahead when I sold the house about 12 years later.

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    Welcome to Money.SE. I don't know where you got this calculation but it's not quite right. A $200K/6% mortgage has a payment of $1200 (1199, but I round). $1000 the first month is interest, $200 principal. An extra payment is about 6 months' principal paid ahead, 6 months the mortgage is cut short. How you got $1200 to save you $115,200 at the end, I don't know, but it's not correct. You might want to look at an online mortgage calculator to understand this better. – JoeTaxpayer Jan 14 '15 at 20:12
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    "Way" ahead? You used money to pay off a 4%, tax-advantaged loan, instead of buying an index fund that would have appreciated at 5-10%. – Malvolio Jan 14 '15 at 23:57
  • A member wrote, then deleted, that an extra payment each and every year would drop the term from 30 years to about 22. He was wise to note your 22 year claim, and I suspect that's the source of your error. – JoeTaxpayer Jan 15 '15 at 1:25
  • @Malvolio - Agree, 100%, index fund. But OP was clear the question was not to go in that direction when answered. – JoeTaxpayer Jan 15 '15 at 1:26
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    "and make one extra payment entirely to principal the first month" should be "..first month of each year." This translates to an additional 22 payments (or slightly less than 2 years to save 8 years. Not quite the value @nocomprende makes it out to be, but certainly worth it in most cases. – Hogan Jan 15 '15 at 17:54
-1

Actually the extra payment comes off the back end of the mortgage. So technically the mortgage is ony reduced one month. However, banks always recalculate the amortization table when the last payment is paid or a payoff amount is requested. There is a difference between the two situations but that is a minor amount. The 30 year note offers flexibility that the 15 does not. Pick one, save money-15 year, get flexibility-30 year.

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    "the mortgage is only reduced one month" - can you explain what you meant by this? – JoeTaxpayer Jan 15 '15 at 0:47
-1

Why won't anyone just answer the original question?

The question was not about opportunity cost or flexibility or family expenses. There are no right answers to any of those things and they all depend on individual circumstances.

I believe the answer to the question of whether paying off a 30-year mortgage in 15 years would cost the same amount as a 15-year mortgage of the same interest rate is yes but ONLY if you pay it off on the exact same schedule as your supposed 15-year. In reality, the answer is NO for two reasons: the amortization schedule; and the fact that the 30-year will always have a higher interest rate than the 15-year.

The way mortgages are amortized, the interest is paid first, essentially. For most people the majority of the monthly payment is interest for the first half of the loan's life. This is good for most people because, in reality, most mortgages only last a couple years after which people refinance or move and for those first couple years the majority of one's housing costs (interest) are tax deductible. It is arguable whether perpetuating this for one's entire life is wise... but that's the reality of most mortgages.

So, unless you pay off your 30-year on the exact same amortization schedule of your theoretical 15-year, you will pay more in interest. A common strategy people pursue is paying an extra monthly payment (or more) each year. By the time you get around to chipping away at your principal in that way, you will already have paid a lot more interest than you would have on a 15-year. And, really, if you can afford to substantially pay down principal in the first year or two of your mortgage, you probably should've borrowed less money to begin with.

In theory, IF the rates were the same (they're not) and IF you paid the 30 off every month in the EXACT same way as you would've paid a 15 (you won't) you will pay the same amount in the end. You have to decide if the flexibility is worth more to you than the cost savings.

For example: a 300k mortgage at 3.5% will have a monthly payment of ~$2150 for a 15-year and ~$1350 for a 30-year, both will start with ~$875/month of that being in interest (gradually declining with time).

What I think most people undervalue is the freedom and peace of mind that comes with a paid off or nearly paid off home... and 15 years is a lot more tangible than 30, plus a lot cheaper over all.

If you can afford a 15-year mortgage without putting too much stress on your budget, it is definitely the better option for financial security.

And be careful of the index fund opportunity cost advice. On average it may be a good idea when you look at the very long run, historically, but a lot of people get less than average returns depending on when they buy and what the market does in the short run. There is no certainty around what returns you will get from the stock market, but if you have a 30-year mortgage there is a lot of certainty around what you will owe every month for the next 30-years. Different mixes of investments make sense for different people, and most people would be wise to get some exposure to the stock market for its returns and liquidity. However, if someone's goal is borrowing more money for their house in order to invest more money in the stock market for their retirement, they would actually be better served in achieving security and independence 15 years sooner.

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    If I sign up for a 30 year mortgage, assume the same rate, and calculate the payment for a 15 year term, I will pay off the mortgage in 15 years if I stick to that plan. I think you said that somewhere in your answer. With 12 answers here already how does your answer differentiate itself from the others? – JoeTaxpayer Sep 29 '15 at 22:15

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