Hunting Happiness

Many of the personal finance books and blogs advocate getting a 15-year mortgage and avoiding 30-year ones like the plague. For disciplined households I do not think this is a cut-and-dried decision. Many sources simply quote the interest paid on each loan, completely ignoring the fact that the comparison is unfair since the longer loan payment is substantially lower. So to make it fair, the comparison needs to include extra prepayment on the longer loan to bring the total monthly payment equal to the shorter loan.

True, going with the 15-year will get you a lower interest rate and thus cut the total interest paid by a nice amount. But, it reduces a ton of flexibility and 15-30 years is a LONG time to give up flexibility.

Let’s look at an example. I also have included the detailed Excel I used so you can play with the numbers yourself. I am assuming a $200,000 home purchased with 20% down. The rate for 30 years is 6% fixed and for 15 years it is 5.5%. I am ignoring real estate taxes, insurance, and PMI since those should be equal. The 15 year will have a monthly PI (principle and interest) of $1,307 while the 30 year will be $959. Assume that with the 30-year loan we pay the $959 per month plus an extra $348 to bring the total to $1,307. The 30-year loan will be paid off in 16-17 years with a total interest cost of $94,936. The straight 15-year loan would have a total interest cost of $81,280.

So, the shorter loan does save us over $13,000 in interest. This is due entirely to the interest rate being a half point lower. That is a sum worth considering. However, with the shorter loan you are locked in to paying that $1,307 every month. If you lose your job, change careers, or have a child, you are still on the hook for that payment. On the other hand, if you opted for the longer loan but chose to still pay the 15-year monthly payment, you have the option to drop down to paying only the $959 a month, which is 27% less.

However, I do agree completely that it is critical not to overspend when purchasing a house. I agree that a good way to judge that is consider the 15-year payment. If that is not palatable, you probably need to look at a less expensive home.

And finally, those who play 100% by the numbers will tell you that the best option is to pay as little as possible each month (even to the extreme of using interest-only loans) and funnel all the extra money into a higher-yield longer-term vehicle like mutual funds. This is mathematically the best long term option, assuming current low interest rates and assuming the stock market 20-year average holds.

So what do we do? We have a thirty year mortgage and pay a little extra each month. The current track has the home paid off around 6 years early.

Get the Excel file here to tinker yourself.