Mortgage – 15 year term vs 30

In the day to day conversations about money there are probably a good dozen recurring themes that are brought up frequently. One of them is refinancing the mortgage, and with rates as low as they are today, the debate of 15 vs 30 year terms is still being tossed around. There are compelling arguments for both sides, after all, wouldn’t it be cool, at say, 25 years of age, to know you’ll live in a fully paid for house by age 40? But wait, wouldn’t it be cooler still to have money owed out at 4% or less but see it grow at 10% per year or more, and 15 years into the mortgage have an investment account worth three times the remaining balance? Good luck, the ’00s would have scared you straight. (Am I the only one that recalls the documentary Scared Straight?)

Back, even in the 90’s the choice was a bit simpler. Mortgage rates were higher and the ratio of the payment for 15 years term was lower. ?? I lost you? Ok, let me walk you through this:

I calculated the payments on a $200,000 loan, with rates over 7%, and the rates you’ll see today. You can see that it would have taken a 29% higher payment to bring the 7.5% mortgage down to 15 years and the lower 7% rate. Of course today, we get to start at 4% for a 30 year fixed, but as you can see, the payment is a full 50% higher to pull the term into 15 years. Sound strange? It did to me until I realized that if we took this to an extreme, a loan at zero percent, it would take twice the payment to pay the loan off in half the time. When rates were truly insane (18 percent mortgage anyone?) it would take less than 5% higher payments to knock 15 years off that mortgage.

Note – the 15 year term typically comes with a slightly lower rate, about 1/2%, this isn’t fixed, you need to see what rates your bank offers for each term.

There are some good things to consider before going for the 15:

• Are you depositing to the match in your 401(k)?
• Is all higher interest debt paid off?
• Are you planning to expand the family?
• Might you or your spouse change jobs or reduce hours?
• Is your emergency fund sufficiently funded?
• Have you and your spouse sat down to create a budget that accounts for 100% of your known expenses?
• Do you have plans for your roof, furnace, air conditioner, hot water heater, and all appliances to be replaced?

You see where all this is going. If you were looking at having your mortgage payment be a reasonable 20% of your income, going for the 15 year term pushes you to commit to 30%. Considering the chunk that goes to taxes, retirement savings, food, etc, it’s this 10% push that may leave you in a bind.

Note, my view of this shifts as one gathers assets over the years, or pays the mortgage down to where the 15 year is a small portion of their income. Our current mortgage is half of what it was when we bought the house, and the rate is also half, so the payment for our mortgage after the last refinance accounts for less than 10% of our monthly income even though it’s a 15 year term.

What do you think? Is a 15 year mortgage risky for you because it ties up too much monthly cash?