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Clients invariably ask the question: Which is better, a 15 year or a 30 year mortgage?
The conventional argument compares the interest paid in each scenario. The reasoning goes something like this: the 15 year option is superior because you will pay less interest to the bank than you will with a 30 year mortgage.
Before I get into an analysis, let me first say that for a certain segment of the population (you know who you are), it does not matter one bit whether the analysis shows one option is superior to the other. To these people, the thought of having a mortgage, any mortgage, keeps them up at night, and they will do everything in their power to pay off their mortgage as quickly as possible no matter what the numbers show. For my clients with this mindset, even though I don’t believe it makes sense financially, I am OK if they pay off their mortgage as quickly as they want. The peace of mind that they enjoy by not having a mortgage liability and related monthly payment is the driver in this decision, and it often outweighs any financial analysis I can provide.
With that said, most people are not like this, so let’s look at an example.
Let’s compare a $500,000 loan, with a 15 and 30 year duration, both at 4%. Without any critical analysis, the conventional argument and numbers seem compelling.
15 Year Mortgage
30 Year Mortgage
Right off the bat, we see that the 15 year mortgage results in about a 55% higher monthly payment, but the 30 year mortgage translates to 117% more interest paid. If you can afford the higher payment, then the 15 year option is the clear winner, right?
Not so fast. Let’s assume that that the borrower selects the 30 year option and deposits the difference into a cash accumulation account, with the objective of using the accumulated dollars to pay off the mortgage early. The difference between the 15 year and 30 year option is $1,311.36/month. So, each year the borrower would be saving $15,736.32.
In 15 years, if we assume a net 4% rate of return, this account would grow to $327,695. Ironically, after 15 years of paying the 30 year mortgage, the outstanding balance is $322,713.
At this point, assuming no pre-payment penalty on the mortgage, the borrower could use the savings in the cash accumulation account to pay off the loan! In this scenario, the outcome is the same. The amount borrowed, the interest rate and total monthly payments are equal. In addition, the house is paid off in 15 years.
Other Practical Issues to Consider
Deductible Interest. With the 30 year mortgage, the borrower pays $252,388 in interest over the first 15 years. With the 15 year mortgage, the total interest is $165,719. If the home owner is able to itemize deductions, the 30 year option provides about 52% more in deductible interest over the first 15 years (one of the few tax deductions the IRS still allows).
Lower Risk of Default. In a household that can afford the 15 year mortgage, but goes with the 30 year option, there is additional appeal. In the case of a job loss, whether it is due to economic conditions or disability, you have cash on hand to make the monthly payments, whereas with the 15 year mortgage, your equity is tied up in the home.
Opportunity. The accumulated savings can also be accessed if other financial opportunities arise, whereas with the 15 year option, the accumulation of equity is tied up in the home. And, let us not forget that real estate is not guaranteed to retain its value. In fact, it can often lose its value as we saw in 2008.
Apples to Apples Time Horizon. To do a true analysis, it is important to compare both options over a 30-year time horizon. In other words, what might your financial position look like after 30 years regardless of which mortgage option you choose?
If you choose the 30 year option over the 15 year option, you could effectively save the monthly payment difference for 30 years. As noted above, this is $15,736.62/year. If you earned 5% on this money for 30 years, then your account would grow to $1,097,756.
If you choose the 15 year option and don’t begin saving until after you’ve paid off your mortgage after 15 years, then you would be able to save $44,381.28/year (12 monthly payments of $3,698.44) from year 16 – 30. At the same 5%, this would yield $1,005,562.
At the end of the 30 year study period, the 30 year mortgage option leaves our borrower with an additional $92,194, and the equity in the house is the same at this point regardless of which mortgage you choose!
So, while the conventional argument for the 15 year over the 30 year option seems to make sense on its face, a deeper dive reveals that the 30 year mortgage affords the home buyer more options and is the better choice over the long run.
But, you may be thinking, 30 year mortgages usually have higher interest rates than their 15 year counterparts. In addition, interest rates are at all-time lows, so how can the separate cash accumulation account deliver returns equal to 4% so that in year 15 the balance is enough to pay off the remaining principal on the loan?
Let’s put it to the test. Let’s compare the same 30 year mortgage at 4% with a 15 year mortgage at 3.5%. This means that the monthly difference in payments between the 15 year and 30 year option is only $1,187.33 per month (not the $1,311.36 in our previous example). This translates to $14,248year deposited into the wealth accumulation account. Let’s couple this with the assumption that the wealth accumulation account only nets 2% return over the next 15 years.
After 180 monthly payments (or 15 years), the 30 year mortgage still has an outstanding balance of $322,713 as in our previous example. The accumulation account in this example, though, has only $251,325. This is a deficiency of $71,388.
Even with the deficiency, the $71,000 gap can be eliminated in just about 4 years, and in 3 years with a net rate of 4%.
Is this a bad tradeoff for the tax benefits, accessibility, flexibility and control that come with establishing a wealth accumulation account? The ultimate issue is the value you place on having personal control over your life. I personally feel that having control over the liquid cash accumulation account is preferable to having the equity tied up in a house. If you ever need access to capital, you are at the mercy of the bank allowing you to access your home equity; with the wealth accumulation account, on the other hand, you control your asset.
Every situation is of course unique. My overall opinion, though, is that the 30 year mortgage is superior to the 15 year mortgage for anybody that is trying to decide between the two.
Jeffrey W. Kirshner, CPA*, PFS, MBA
The Illuminated Wealth Solution ™
Jeffrey W. Kirshner is a Registered Representative and Financial Advisor of Park Avenue Securities LLC (PAS). OSJ: 5080 40th Street, Suite 400, Phoenix, AZ 85018, (602)957-7155. Securities products and advisory services offered through PAS, member FINRA, SIPC. Financial Representative of The Guardian Life Insurance Company of America® (Guardian), New York, NY. PAS is an indirect, wholly-owned subsidiary of Guardian. KIRSHNER & KLARFELD FINANCIAL GROUP, LLC is not an affiliate or subsidiary of PAS or Guardian.
*Not Practicing for Guardian or any subsidiaries of affiliates thereof
The views and opinions expressed herein are solely that of the author and do not represent the views or opinions of The Guardian Life Insurance Company of America, or its subsidiaries or affiliates thereof
Guardian, its subsidiaries, agents, and employees do not provide tax, legal, or accounting advice. Consult your tax, legal, or accounting professional regarding your individual situation. Guardian does not issue nor advise for mortgages.
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