Buying a house, 15yr vs 30yr loan?

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TheBogleWay
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Buying a house, 15yr vs 30yr loan?

Post by TheBogleWay » Sat Jan 27, 2018 10:46 pm

Hey BH,

I'm sure a LOT of you know the answer to this, and I'm really hoping there's one "better" answer here.

I'm considering buying a home soon, and need to decide on a 15 year mortgage vs 30 years. The goal is long term wealth if that isn't obvious, how do I end up with the most money. Obviously with a longer loan I'm comfortable getting a little more house.

The main question is keeping money in the stock market vs using that extra money to pay off your mortgage in half the time. - as an amateur, my instinct is that a home is costing 4%, while the market gains 8, therefore keep money in the market and go 30 year.. but I'm SURE there's something missing.

Let's use a million dollar home as an example for simple math.

I have enough to put 20% down.. I guess that's another question. It's better to put 20% down right, for a better rate? Instead of keeping the $200k invested?

Some other details about my situation:
Credit is "good" borderline excellent.
Financial situation is good, assuming I'd get a good interest rate on a loan.
First home.
Using lazy 3 fund portfolio.

Any guidance as to which is better assuming the market performs at say.. 8%?

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Re: Buying a house, 15yr vs 30yr loan?

Post by grabiner » Sat Jan 27, 2018 10:59 pm

This is really the same type of question as the usual decision as in Paying down loans versus investing on the wiki. If you view a mortgage as a negative bond, then paying down a mortgage is equivalent to buying a bond portfolio. With the shorter-term mortgage, you will be buying more "bonds" as you make the larger payments, so a fair comparison involves selling bonds, not stocks, to make the larger payments.

The higher rate on the longer-term mortgage is not a clear indication against it, though; in return for that higher rate, you retain the right to lock in the low rate for a longer time. In 15 years, you might still have the 30-year mortgage with a large balance owed, but be paying 4% interest while your bond fund is earning 7%. The bank is taking that risk, which is why it charges a higher rate.

The bank views the choice as fair. Therefore, you should look at your own situation; do you benefit more or less than others from the longer term? For example, if you can't max out your retirement accounts while paying the 15-year loan, you should use the 30-year and put more in your 401(k). If you can't deduct the interest, you should prefer the 15-year loan because there is a larger difference in effective interest rates for you than for the bank. If you are likely to move in ten years, or if you are considering making extra mortgage payments, you don't get the benefit of locking in a low rate for 30 years, which makes the 15-year more attractive.
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Re: Buying a house, 15yr vs 30yr loan?

Post by GTBuzz » Sat Jan 27, 2018 11:06 pm

The Finance Buff has a popular post in regards to this exact question. It even contains a link to a spreadsheet where you can enter your own interest rate, tax rate and investment return assumptions:

https://thefinancebuff.com/borrow-30-ye ... rence.html

Several months ago, I would have said a 15-year mortgage is a slam dunk. Rates between the two have converged in recent months, though, so it's probably not quite as clear cut. I do think, though, that a 15-year fixed still has the edge, particularly if you will not be itemizing going forward with the tax bill's new, higher standard deduction. Keep in mind that 8 percent returns going forward would be seen as an aggressive assumption by many here at today's high valuations. I think something in the 4 to 5 percent range would be a more appropriate assumption.

I would also add that I cannot think of a scenario where you should NOT put 20% down. IMHO, if you cannot afford to put 20% down, you cannot afford that home.

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Re: Buying a house, 15yr vs 30yr loan?

Post by camillus » Sat Jan 27, 2018 11:24 pm

TheBogleWay wrote:
Sat Jan 27, 2018 10:46 pm
The goal is long term wealth if that isn't obvious, how do I end up with the most money. Obviously with a longer loan I'm comfortable getting a little more house.
Purchase price is an important variable in this calculation. If a 30 yr mortgage is going to entice you to buy more house, I'd say go with a 15 year.

In my experience, during the process of buying a house or car, the price my wife and I are willing to pay increases as we get more emotional.

Locking yourself into a 20% down, 15 year fixed mortgage has the major side benefit (apart from interest rate arbitrage, which is what this thread seems to be about) of constraining you to an budgeted price.

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Re: Buying a house, 15yr vs 30yr loan?

Post by TheBogleWay » Sun Jan 28, 2018 12:25 am

grabiner wrote:
Sat Jan 27, 2018 10:59 pm
This is really the same type of question as the usual decision as in Paying down loans versus investing on the wiki. If you view a mortgage as a negative bond, then paying down a mortgage is equivalent to buying a bond portfolio. With the shorter-term mortgage, you will be buying more "bonds" as you make the larger payments, so a fair comparison involves selling bonds, not stocks, to make the larger payments.

The higher rate on the longer-term mortgage is not a clear indication against it, though; in return for that higher rate, you retain the right to lock in the low rate for a longer time. In 15 years, you might still have the 30-year mortgage with a large balance owed, but be paying 4% interest while your bond fund is earning 7%. The bank is taking that risk, which is why it charges a higher rate.

The bank views the choice as fair. Therefore, you should look at your own situation; do you benefit more or less than others from the longer term? For example, if you can't max out your retirement accounts while paying the 15-year loan, you should use the 30-year and put more in your 401(k). If you can't deduct the interest, you should prefer the 15-year loan because there is a larger difference in effective interest rates for you than for the bank. If you are likely to move in ten years, or if you are considering making extra mortgage payments, you don't get the benefit of locking in a low rate for 30 years, which makes the 15-year more attractive.

I read that, any chance you can put your response in more laymens terms for me? After that reading, I didn't really understand a clear answer.

And for added data that would help you, yes, even with a 15 year loan I could afford to max our 401k and backdoor Roth IRA and still have money left over to invest.

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Re: Buying a house, 15yr vs 30yr loan?

Post by TheBogleWay » Sun Jan 28, 2018 12:26 am

camillus wrote:
Sat Jan 27, 2018 11:24 pm
TheBogleWay wrote:
Sat Jan 27, 2018 10:46 pm
The goal is long term wealth if that isn't obvious, how do I end up with the most money. Obviously with a longer loan I'm comfortable getting a little more house.
Purchase price is an important variable in this calculation. If a 30 yr mortgage is going to entice you to buy more house, I'd say go with a 15 year.

In my experience, during the process of buying a house or car, the price my wife and I are willing to pay increases as we get more emotional.

Locking yourself into a 20% down, 15 year fixed mortgage has the major side benefit (apart from interest rate arbitrage, which is what this thread seems to be about) of constraining you to an budgeted price.
I see what you're saying and appreciate the reply, but I don't need a "tool" to keep my spending in check. This is still relatively frugal.

I'm simply wondering which method results in more net worth over time.

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Re: Buying a house, 15yr vs 30yr loan?

Post by randomizer » Sun Jan 28, 2018 12:27 am

I'd want to see the rates.
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Re: Buying a house, 15yr vs 30yr loan?

Post by camillus » Sun Jan 28, 2018 1:12 am

TheBogleWay wrote:
Sun Jan 28, 2018 12:26 am
I'm simply wondering which method results in more net worth over time.
Since you would be buying one house with a 15 yr and a variably larger one with the 30 yr, no one here can tell you :wink:

IF the purchase price is constant and IF you diligently invest the difference in payment between the 15 and the 30 year mortgage, you will likely come out ahead with a 30 year mortgage.

The larger part of this equation is behavioral and not financial. You have to resist the urge to buy more house now and the urge - over three decades - to use extra cash flow for consumption. If you have a handle on that, go with the 30 yr.

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Re: Buying a house, 15yr vs 30yr loan?

Post by clown » Sun Jan 28, 2018 2:15 am

Let's get out of the realm of theory and get down to dollars.

Your loan of $800k is referred to as a "jumbo" loan. Even with good credit and 20% down, jumbo rates are higher than rates for lower loans. Let's assume today's jumbo rate is 5.5% for 15 years and 4.5% for 30 years. Actual rates may be different, but I want you to see where I am going with this.

$800K loan for 30 yrs at 4.5% means monthly payments of $4053.48 and lifetime interest of $659,254.
$800K loan for 15 yrs at 5.5% means monthly payments of $6536.67 and lifetime interest of $376,601.
$800K loan for 30 yrs at 4.5% with monthly payments of $6536.67 has lifetime interest of $278,551

The first two lines above illustrate a 15 year and 30 year traditional fixed rate loan. Obviously, you save a ton of interest with the 15 year loan depicted on the second line.

But what it you took a 30 year loan and paid at the 15 year pace? Check out the third line above. You pay it off in only 165 months (13 yrs 9 months) and save a bunch more interest. You don't have to make special arrangements with the lender -- just pay more than the loan would require. You would sign paperwork for a 30 year loan requiring payments of $4053 but make payments of $6537. The additional amount goes toward principal. And because the principal goes down faster, the interest is substantially less and the loan is paid off quicker.

If you want to double check the above figures, get an amortization table like the one built into Excel.

Please note --your paperwork may say that prepayments are only permissible once a year. In that case, make the lower payments and put aside the difference -- so that you can make a prepayment of $29,808 every year. That scenario would not be as favorable as making the larger monthly payments, because principal is not paid down as fast. Better still, find a lender that will allow you to make the larger payments monthly.

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Re: Buying a house, 15yr vs 30yr loan?

Post by TheBogleWay » Sun Jan 28, 2018 3:03 am

clown wrote:
Sun Jan 28, 2018 2:15 am
Let's get out of the realm of theory and get down to dollars.

Your loan of $800k is referred to as a "jumbo" loan. Even with good credit and 20% down, jumbo rates are higher than rates for lower loans. Let's assume today's jumbo rate is 5.5% for 15 years and 4.5% for 30 years. Actual rates may be different, but I want you to see where I am going with this.

$800K loan for 30 yrs at 4.5% means monthly payments of $4053.48 and lifetime interest of $659,254.
$800K loan for 15 yrs at 5.5% means monthly payments of $6536.67 and lifetime interest of $376,601.
$800K loan for 30 yrs at 4.5% with monthly payments of $6536.67 has lifetime interest of $278,551

The first two lines above illustrate a 15 year and 30 year traditional fixed rate loan. Obviously, you save a ton of interest with the 15 year loan depicted on the second line.

But what it you took a 30 year loan and paid at the 15 year pace? Check out the third line above. You pay it off in only 165 months (13 yrs 9 months) and save a bunch more interest. You don't have to make special arrangements with the lender -- just pay more than the loan would require. You would sign paperwork for a 30 year loan requiring payments of $4053 but make payments of $6537. The additional amount goes toward principal. And because the principal goes down faster, the interest is substantially less and the loan is paid off quicker.

If you want to double check the above figures, get an amortization table like the one built into Excel.

Please note --your paperwork may say that prepayments are only permissible once a year. In that case, make the lower payments and put aside the difference -- so that you can make a prepayment of $29,808 every year. That scenario would not be as favorable as making the larger monthly payments, because principal is not paid down as fast. Better still, find a lender that will allow you to make the larger payments monthly.

Quick question about this, for you, and hopefully someone else other than us reading this.

1) Aren't interest rates higher for longer loans? I was surprised to see you say a higher interest rate for paying it off faster. Was that a typo or does that really happen with mortgages?

2) Here's my extremely basic response and follow up to your post. Let's use line one of your examples. So my monthly payment is $4053. What if... instead of paying an extra $2,500 towards the loan per month, I invested that $2,500/month? Over 30 years, with an 8% return (stock market) I'd have $3,670,000. Which, is obviously more than the $381,000 in interest I'd save by putting that towards a higher monthly payment.

In essence, making it a much smarter decision (significant) to invest that spare money instead of use it to pay off the loan faster.

Am I missing something?

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Re: Buying a house, 15yr vs 30yr loan?

Post by rama13 » Sun Jan 28, 2018 5:37 am

clown's post is completely wrong. Longer term loans are going to have a higher rate, all else being equal. Using real numbers from Friday: a 30-yr loan is about 4.125% and a 15-yr is around 3.625%.

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Re: Buying a house, 15yr vs 30yr loan?

Post by camillus » Sun Jan 28, 2018 5:37 am

TheBogleWay wrote:
Sun Jan 28, 2018 3:03 am
1) Aren't interest rates higher for longer loans? I was surprised to see you say a higher interest rate for paying it off faster. Was that a typo or does that really happen with mortgages?
That looks like a mistake. A 30 year mortgage paid off in 15 years will still charge slightly more in total interest than a 15 year mortgage.

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Re: Buying a house, 15yr vs 30yr loan?

Post by TheBogleWay » Sun Jan 28, 2018 7:10 am

camillus wrote:
Sun Jan 28, 2018 5:37 am
TheBogleWay wrote:
Sun Jan 28, 2018 3:03 am
1) Aren't interest rates higher for longer loans? I was surprised to see you say a higher interest rate for paying it off faster. Was that a typo or does that really happen with mortgages?
That looks like a mistake. A 30 year mortgage paid off in 15 years will still charge slightly more in total interest than a 15 year mortgage.
Understood.

Well, regarding my #2 part of that where I did my simple math, isn't it in my best financial interest to do a 30 year term and minimize the payments, so I can put the remainder/what I save in stocks?

I did that with my car loan because that's pretty straight forward. Sure I could pay it off but the interest on the loan was 4% and I expected the market would be that.

Does the same thinking apply to a mortgage?

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Re: Buying a house, 15yr vs 30yr loan?

Post by Olemiss540 » Sun Jan 28, 2018 7:41 am

TheBogleWay wrote:
Sun Jan 28, 2018 7:10 am
camillus wrote:
Sun Jan 28, 2018 5:37 am
TheBogleWay wrote:
Sun Jan 28, 2018 3:03 am
1) Aren't interest rates higher for longer loans? I was surprised to see you say a higher interest rate for paying it off faster. Was that a typo or does that really happen with mortgages?
That looks like a mistake. A 30 year mortgage paid off in 15 years will still charge slightly more in total interest than a 15 year mortgage.
Understood.

Well, regarding my #2 part of that where I did my simple math, isn't it in my best financial interest to do a 30 year term and minimize the payments, so I can put the remainder/what I save in stocks?

I did that with my car loan because that's pretty straight forward. Sure I could pay it off but the interest on the loan was 4% and I expected the market would be that.

Does the same thinking apply to a mortgage?
What you missed above, was that in year 16 through 30 you would be able to invest the full mortgage payment into the market to increase your net worth if you had a 15 year mortgage (since the house would be paid off).

If you assume a higher rate of return in the stock market, than you will always end up with an assumed higher NW in the end by leveraging a lower rate debt to invest. The problem is trying to decide how the risk adjusted return compares (or risk premium that the market volatility is worth). You will notice a large percentage around here (vast majority) suggest between 20% and 50% bonds in your AA. It's not due to higher expected bond returns, but lower expected volitility. Same with deciding to leverage to invest. Leveraging juices returns by increasing volatility.

The answer in my opinion lies in what your savings rate would be with either scenario. If you need a 30 year mortgage to maintain a 20-25% savings rate, than I suggest that route. If you are buying a conservatively priced house for your income and will be able to maintain a 25-30% savings rate with a 15 year mortgage than I suggest a 15yr mortgage because you will have more predictable future financial success without the need to take as much risk in the market.. Hope that makes sense and good luck,
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Re: Buying a house, 15yr vs 30yr loan?

Post by gerntz » Sun Jan 28, 2018 9:08 am

With new $750K limit on mortgage interest deduction, I think any mortgage larger than that more & more favors 15 years the larger over $750K it gets; i.e., you don't want to be paying interest you can't deduct.

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Re: Buying a house, 15yr vs 30yr loan?

Post by grabiner » Sun Jan 28, 2018 10:14 am

TheBogleWay wrote:
Sun Jan 28, 2018 7:10 am
Well, regarding my #2 part of that where I did my simple math, isn't it in my best financial interest to do a 30 year term and minimize the payments, so I can put the remainder/what I save in stocks?

I did that with my car loan because that's pretty straight forward. Sure I could pay it off but the interest on the loan was 4% and I expected the market would be that.

Does the same thinking apply to a mortgage?
It doesn't apply to either one of these. Yes, you expect higher returns from the market, but you have chosen your investments to balance return and risk. You should decide separately how much risk to take (how much stock to hold) and whether to pay down a loan (which increases or decreases your return for the same level of risk). See Paying down loans versus investing on the wiki.

Consider the following four choices.

A. Put the loan balance in bonds.
B. Pay off the loan.
C. Put the loan balance in stock.
D. Pay off the loan, and move an amount equal to the loan balance from bonds to stock.

If the loan is a five-year car loan at 4%, then A and B have the same risk if you hold low-risk, short-term bonds (or CDs), since those bonds will make fixed payment over the next five years. B is clearly better than A, since short-term bonds and CDs yield less than 4%. By the same logic, D is better than C; in both scenarios, you have the same risk level, and in D, you got rid of bonds yielding less than the loan interest rate.

Therefore, you should pay off the loan, and then decide based on your risk tolerance whether to buy more stock.

For a mortgage, it isn't as clear, because the bonds which are a fair comparison are long-term. In your example, with an $800K mortgage, interest on the first $50K is not deductible, and thus paying the loan down to $750K (ideally with a larger down payment) is beneficial. But beyond that, the after-tax return on municipal bonds is close to the after-tax return on a mortgage, given that you are deducting the interest in a high tax bracket. (Even under the new tax laws, you will deduct most of the mortgage interest.)

Thus, if you don't have any liquidity issues, it is a close decision. I would be inclined to go with the 30-year if you are in a high-tax state and Vanguard has a muni fund for your state; in CA, you would pay no tax on CA munis, and could deduct over 40% of the mortgage interest.

My own decision in this situation was to go with a 15-year loan. The rate difference at the time was 3% versus 4%. While I live in high-tax MD, I don't have a good taxable investment exempt from MD state tax, as Vanguard doesn't have a MD fund and T. Rowe Price's fund costs more in extra expenses than it saves in taxes. Therefore, I deduct the interest at only 28% then, 24% now.
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Re: Buying a house, 15yr vs 30yr loan?

Post by hightower » Sun Jan 28, 2018 10:44 am

With the loss of full SALT deductions, I will no longer be itemizing on my tax returns. Therefore it is best for me to pay off my mortgage faster and have a lower interest rate. I am currently in the process of refinancing to a 15 year mortgage at 3.25%. Just had my appraisal the other day and should close in the next few weeks.

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Re: Buying a house, 15yr vs 30yr loan?

Post by chevca » Sun Jan 28, 2018 11:49 am

This is a fun exercise isn't it? But, OP, a good thing to remember is that most folks don't stay in a first home (assuming this is your first) for 30 or even 15 years. What's the average 5 years or so? I think it's much better to figure out what's best now rather than 30 years from now. If you can afford the 15 easily now and still have extra each month, go that route. Why pay more interest than you need to and you build equity quicker.

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Re: Buying a house, 15yr vs 30yr loan?

Post by TheBogleWay » Tue Jan 30, 2018 11:10 pm

Olemiss540 wrote:
Sun Jan 28, 2018 7:41 am
TheBogleWay wrote:
Sun Jan 28, 2018 7:10 am
camillus wrote:
Sun Jan 28, 2018 5:37 am
TheBogleWay wrote:
Sun Jan 28, 2018 3:03 am
1) Aren't interest rates higher for longer loans? I was surprised to see you say a higher interest rate for paying it off faster. Was that a typo or does that really happen with mortgages?
That looks like a mistake. A 30 year mortgage paid off in 15 years will still charge slightly more in total interest than a 15 year mortgage.
Understood.

Well, regarding my #2 part of that where I did my simple math, isn't it in my best financial interest to do a 30 year term and minimize the payments, so I can put the remainder/what I save in stocks?

I did that with my car loan because that's pretty straight forward. Sure I could pay it off but the interest on the loan was 4% and I expected the market would be that.

Does the same thinking apply to a mortgage?
What you missed above, was that in year 16 through 30 you would be able to invest the full mortgage payment into the market to increase your net worth if you had a 15 year mortgage (since the house would be paid off).

If you assume a higher rate of return in the stock market, than you will always end up with an assumed higher NW in the end by leveraging a lower rate debt to invest. The problem is trying to decide how the risk adjusted return compares (or risk premium that the market volatility is worth). You will notice a large percentage around here (vast majority) suggest between 20% and 50% bonds in your AA. It's not due to higher expected bond returns, but lower expected volitility. Same with deciding to leverage to invest. Leveraging juices returns by increasing volatility.

The answer in my opinion lies in what your savings rate would be with either scenario. If you need a 30 year mortgage to maintain a 20-25% savings rate, than I suggest that route. If you are buying a conservatively priced house for your income and will be able to maintain a 25-30% savings rate with a 15 year mortgage than I suggest a 15yr mortgage because you will have more predictable future financial success without the need to take as much risk in the market.. Hope that makes sense and good luck,


Our combined income (on the conservative end) should average about $310,000/year on the slow years. Cost of living for both of us should be roughly $65k/year with $2,500 in rent. So if we increase that to a $6,500 morgtage/taxes payment then cost of living increases to $113,000. A very rough estimate of after tax-take home is $210,000, if we spent $113,000 to live our savings rate should still be well above 25-30% savings.

If she has kids, I'll lose her $70k/year income and cost of living will increase slightly but I think that leaves us around 30% savings rate.

So according to your post, I'll end up better off if I do a 15 year mortgage? Here are some rough numbers.

1 million dollar home for math:
A) 15 year mortgage at 3.7% interest. For easy math, let's just say the monthly payment was $6,500 for everything. I pay off the loan in 15 years, and year 16-30 I can contribute entire $6,500 into my investments (60% US, 20% INTL and 20% BND). Rough math, at year 30, I'd have $2,287,000 in bucket A, which is essentially just that mortgage payment starting at 0, and invested at 8% interest years 16-30. Then, I'd also have say... a few hundred thousand saved in interest due to the lower interest rate. Maybe... 2.6 million?

B) 30 year mortgage at 4.2% interest. For easy math, let's just say the monthly payment was $4,500 for everything. In this example, my monthly payment is $2,000 less than option A. At the end, basically calculating an extra $2,000 towards my stocks (60% US, 20% INTL, and 20% BND) I'll have about $2,936,000. Minus a couple hundred thousand extra spent on interest due to the higher interest rate. So... surprisingly, I'd end up with about $2.6 give or take.

That surprised me, both options leave me with close to the same dollar amount. It's very rough math... I'm not fully understanding some of the replies. I'll keep trying.

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Re: Buying a house, 15yr vs 30yr loan?

Post by TheBogleWay » Tue Jan 30, 2018 11:12 pm

chevca wrote:
Sun Jan 28, 2018 11:49 am
This is a fun exercise isn't it? But, OP, a good thing to remember is that most folks don't stay in a first home (assuming this is your first) for 30 or even 15 years. What's the average 5 years or so? I think it's much better to figure out what's best now rather than 30 years from now. If you can afford the 15 easily now and still have extra each month, go that route. Why pay more interest than you need to and you build equity quicker.
I don't understand this reply. What do you mean?

and the reason someone might pay a higher interest rate (slightly) for a longer loan is because they would use those additional saved funds to invest in the market, resulting in a higher net worth.

TheBogleWay
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Re: Buying a house, 15yr vs 30yr loan?

Post by TheBogleWay » Tue Jan 30, 2018 11:16 pm

grabiner wrote:
Sun Jan 28, 2018 10:14 am
It doesn't apply to either one of these. Yes, you expect higher returns from the market, but you have chosen your investments to balance return and risk. You should decide separately how much risk to take (how much stock to hold) and whether to pay down a loan (which increases or decreases your return for the same level of risk). See Paying down loans versus investing on the wiki.

Consider the following four choices.

A. Put the loan balance in bonds.
B. Pay off the loan.
C. Put the loan balance in stock.
D. Pay off the loan, and move an amount equal to the loan balance from bonds to stock.

If the loan is a five-year car loan at 4%, then A and B have the same risk if you hold low-risk, short-term bonds (or CDs), since those bonds will make fixed payment over the next five years. B is clearly better than A, since short-term bonds and CDs yield less than 4%. By the same logic, D is better than C; in both scenarios, you have the same risk level, and in D, you got rid of bonds yielding less than the loan interest rate.

Therefore, you should pay off the loan, and then decide based on your risk tolerance whether to buy more stock.

For a mortgage, it isn't as clear, because the bonds which are a fair comparison are long-term. In your example, with an $800K mortgage, interest on the first $50K is not deductible, and thus paying the loan down to $750K (ideally with a larger down payment) is beneficial. But beyond that, the after-tax return on municipal bonds is close to the after-tax return on a mortgage, given that you are deducting the interest in a high tax bracket. (Even under the new tax laws, you will deduct most of the mortgage interest.)

Thus, if you don't have any liquidity issues, it is a close decision. I would be inclined to go with the 30-year if you are in a high-tax state and Vanguard has a muni fund for your state; in CA, you would pay no tax on CA munis, and could deduct over 40% of the mortgage interest.

My own decision in this situation was to go with a 15-year loan. The rate difference at the time was 3% versus 4%. While I live in high-tax MD, I don't have a good taxable investment exempt from MD state tax, as Vanguard doesn't have a MD fund and T. Rowe Price's fund costs more in extra expenses than it saves in taxes. Therefore, I deduct the interest at only 28% then, 24% now.
It's going to take me some time to get to your level of knowledge, for now, I didn't fully understand your reply.

I keep it simple. My investments roughly follow 60% total US stock market, 20% total international, and 20% bond. I'm about 30. Any saved funds will be invested, we are the type of people where our lifestyle (outside of this home) doesn't increase much because we can, we maintain a relatively stable lifestyle and expenses outside of a home will stay close to the same.

Any chance you can glance at my longer post above, it's about 2 posts above this and tell me if that helps refine your answer?

My state does not have any state income tax.

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Re: Buying a house, 15yr vs 30yr loan?

Post by nordsteve » Wed Jan 31, 2018 12:05 am

When I was younger, I had a 30 year mortgage and paid it at a 15 year rate. Working in tech, with its booms and busts, I wanted the option to pay at the lower rate.

Same outcome can be achieved if you set aside sufficient cash in your emergency fund to cover the difference. Back then all of my savings were in pretax, so couldn't take that approach.

TheBogleWay
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Re: Buying a house, 15yr vs 30yr loan?

Post by TheBogleWay » Wed Jan 31, 2018 3:27 am

nordsteve wrote:
Wed Jan 31, 2018 12:05 am
When I was younger, I had a 30 year mortgage and paid it at a 15 year rate. Working in tech, with its booms and busts, I wanted the option to pay at the lower rate.

Same outcome can be achieved if you set aside sufficient cash in your emergency fund to cover the difference. Back then all of my savings were in pretax, so couldn't take that approach.
There's a person in here above that actually claims that's not the case. I'd say the main reason is because you'll pay a higher interest rate for the 30 year loan vs 15.

chevca
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Re: Buying a house, 15yr vs 30yr loan?

Post by chevca » Wed Jan 31, 2018 7:10 am

TheBogleWay wrote:
Tue Jan 30, 2018 11:12 pm
chevca wrote:
Sun Jan 28, 2018 11:49 am
This is a fun exercise isn't it? But, OP, a good thing to remember is that most folks don't stay in a first home (assuming this is your first) for 30 or even 15 years. What's the average 5 years or so? I think it's much better to figure out what's best now rather than 30 years from now. If you can afford the 15 easily now and still have extra each month, go that route. Why pay more interest than you need to and you build equity quicker.
I don't understand this reply. What do you mean?

and the reason someone might pay a higher interest rate (slightly) for a longer loan is because they would use those additional saved funds to invest in the market, resulting in a higher net worth.
Because for your numbers to work out the way you're figuring everything has to stay the same for 30 years... same house, same mortgage, same income, same expenses. It's HIGHLY unlikely that will all stay the same for you over that time. So, why bother with all this planning?

Compare the two over the next 5 or 10 years. That's likely a better exercise. In that case, the 15 year builds equity faster and you pay less interest. That probably puts you in a better spot when life happens and you move 5 years from now.

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Tamarind
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Re: Buying a house, 15yr vs 30yr loan?

Post by Tamarind » Wed Jan 31, 2018 7:53 am

chevca wrote:
Sun Jan 28, 2018 11:49 am
This is a fun exercise isn't it? But, OP, a good thing to remember is that most folks don't stay in a first home (assuming this is your first) for 30 or even 15 years. What's the average 5 years or so? I think it's much better to figure out what's best now rather than 30 years from now. If you can afford the 15 easily now and still have extra each month, go that route. Why pay more interest than you need to and you build equity quicker.

This. It matters whether this is a home to start, a home to keep till you move, or a home you'll pay off. The way the loan is amortized you don't pay the same amount of interest each month, it's front-loaded.

No matter which term you take, unless you are making extra principle payments or keeping the loan for the full term, you are going to be paying more of the interest than you would expect for [Years Elapsed divided by Loan Term].

If the goal is to keep a particular home forever and maximize wealth, then you can't know the answer for sure because you don't know what the return of the stock market will be. This was my situation and I chose the 15 year loan because I want to retire early and not be paying a mortgage in retirement. I also picked a less expensive house that I can remodel or not based on my future financial situation. Someone else might count on long term interest rate changes and stock performance and go with the 30 year, setting the price of a nicer house in today's dollars and paying it in future (probably cheaper) dollars. Both valid strategies.

If the goal is to move at some point soon and maximize wealth, you still can't know because you have no idea what future houses will cost or what future interest rates will be. But a lot of folks who know they will move soon choose an ARM for the absolute lowest rate they can get... More like leasing a house when done that way. Absolute cost is lower but you are not expecting to build much equity.

My advice to you would be pick a loan you can afford and don't buy too much house.

Olemiss540
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Re: Buying a house, 15yr vs 30yr loan?

Post by Olemiss540 » Wed Jan 31, 2018 8:08 am

TheBogleWay wrote:
Tue Jan 30, 2018 11:10 pm
Olemiss540 wrote:
Sun Jan 28, 2018 7:41 am

What you missed above, was that in year 16 through 30 you would be able to invest the full mortgage payment into the market to increase your net worth if you had a 15 year mortgage (since the house would be paid off).

If you assume a higher rate of return in the stock market, than you will always end up with an assumed higher NW in the end by leveraging a lower rate debt to invest. The problem is trying to decide how the risk adjusted return compares (or risk premium that the market volatility is worth). You will notice a large percentage around here (vast majority) suggest between 20% and 50% bonds in your AA. It's not due to higher expected bond returns, but lower expected volitility. Same with deciding to leverage to invest. Leveraging juices returns by increasing volatility.

The answer in my opinion lies in what your savings rate would be with either scenario. If you need a 30 year mortgage to maintain a 20-25% savings rate, than I suggest that route. If you are buying a conservatively priced house for your income and will be able to maintain a 25-30% savings rate with a 15 year mortgage than I suggest a 15yr mortgage because you will have more predictable future financial success without the need to take as much risk in the market.. Hope that makes sense and good luck,


Our combined income (on the conservative end) should average about $310,000/year on the slow years. Cost of living for both of us should be roughly $65k/year with $2,500 in rent. So if we increase that to a $6,500 morgtage/taxes payment then cost of living increases to $113,000. A very rough estimate of after tax-take home is $210,000, if we spent $113,000 to live our savings rate should still be well above 25-30% savings.

If she has kids, I'll lose her $70k/year income and cost of living will increase slightly but I think that leaves us around 30% savings rate.

So according to your post, I'll end up better off if I do a 15 year mortgage? Here are some rough numbers.

1 million dollar home for math:
A) 15 year mortgage at 3.7% interest. For easy math, let's just say the monthly payment was $6,500 for everything. I pay off the loan in 15 years, and year 16-30 I can contribute entire $6,500 into my investments (60% US, 20% INTL and 20% BND). Rough math, at year 30, I'd have $2,287,000 in bucket A, which is essentially just that mortgage payment starting at 0, and invested at 8% interest years 16-30. Then, I'd also have say... a few hundred thousand saved in interest due to the lower interest rate. Maybe... 2.6 million?

B) 30 year mortgage at 4.2% interest. For easy math, let's just say the monthly payment was $4,500 for everything. In this example, my monthly payment is $2,000 less than option A. At the end, basically calculating an extra $2,000 towards my stocks (60% US, 20% INTL, and 20% BND) I'll have about $2,936,000. Minus a couple hundred thousand extra spent on interest due to the higher interest rate. So... surprisingly, I'd end up with about $2.6 give or take.

That surprised me, both options leave me with close to the same dollar amount. It's very rough math... I'm not fully understanding some of the replies. I'll keep trying.
Closer, but you do not subtract interest saved from both scenarios. In the math you laid out, it would be 2.3MM vs 2.6MM after 30 years. You wouldn't add 300k in extra interest from scenario A since you already subtracted it from scenario B as an expense.

Savings rate looks great considering non-housing expenses are around 65k, but I would be concerned once kids come and spouse quits work it would get tight. Kids aren't cheap and a 6500 mort on a 240k salary is going to eat a TON of cashflow along with child expenses. Probably doable, but would feel much easier with a good cash buffer in hand. Good luck!
I hold index funds because I do not overestimate my ability to pick stocks OR stock pickers.

nordsteve
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Re: Buying a house, 15yr vs 30yr loan?

Post by nordsteve » Wed Jan 31, 2018 10:35 am

TheBogleWay wrote:
Wed Jan 31, 2018 3:27 am
nordsteve wrote:
Wed Jan 31, 2018 12:05 am
When I was younger, I had a 30 year mortgage and paid it at a 15 year rate. Working in tech, with its booms and busts, I wanted the option to pay at the lower rate.

Same outcome can be achieved if you set aside sufficient cash in your emergency fund to cover the difference. Back then all of my savings were in pretax, so couldn't take that approach.
There's a person in here above that actually claims that's not the case. I'd say the main reason is because you'll pay a higher interest rate for the 30 year loan vs 15.
I wasn't very clear in my original post.

Much of your thinking is around optimizing for the "happy path" scenario. My goal at the time was to optimize for wealth increase, but one of my subgoals was to "minimize the chance that job loss would cause me to lose our house," and I was willing to pay a bit more over the term of the loan to do so.

Suppose for the purposes of discussion that you wanted to be resilient to 2 years without work. Let's analyze how the difference in mortgage payments can contribute to that goal.

Consider a $1,000,000 mortgage with these two scenarios:

30 years -- 4.2% - monthly $4890
15 years -- 3.7% -- monthly $7247

Monthly difference = $2357

One approach is to take a 30 year mortgage, but make payments at the $7247 rate. At any point, you can fall back to the lower 30 year payments with no penalty.

Another approach is to take the 15 year mortgage, but increase your emergency fund by $2357 * 12 * 2 = $56,568. Then you have the cash on hand to cover for two years of the difference in payments. The cash buffer equalizes the cash flow of the two mortgages.

Costs:
30 year mortgage -- 15 year amortization -- interest of $368,192
15 year mortgage -- 15 year amortization -- interest of $304,539

Cost difference between the two approaches: about $4000 a year. Only you can answer whether that's worth it for you. My mortgage at the time was close to an order of magnitude smaller than yours, and interest rates were more than 2x today's rates.

Based on your post, I'm assuming you're young and didn't live through the 2008 recession. Here's a scenario to test your plan against:

1. There's a recession.
2. Housing prices decline to 2/3 of current prices, putting you in negative equity, like this: https://fred.stlouisfed.org/series/SEXRNSA/ Maybe this puts you in negative equity.
3. Equity prices decline by 50% (like in 2008)
4. One or both of you lose your job for 6 months or longer

Finally, you need to make an allowance for costs related to home ownership. Since I bought my house 15 years ago, I've bought a new boiler, new soffit and fascia, replaced several windows, new split AC units, and new roof. Coming up is a new driveway and replacing the patio.

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Re: Buying a house, 15yr vs 30yr loan?

Post by jjface » Wed Jan 31, 2018 10:37 am

As long as you can afford a 15 year mortgage then pick whichever you prefer. It is okay to go with a 30 and invest the extra elsewhere.

If you can't afford a 15yr or it will be pushing things then consider less house.

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Re: Buying a house, 15yr vs 30yr loan?

Post by willthrill81 » Wed Jan 31, 2018 11:03 am

Here's the situation as simply as I can think of it.

If you take out a 30 year mortgage and invest the difference between the 30 year and 15 year mortgage payments into stocks, then you'll very likely end with a higher net worth compared to taking out a 15 year mortgage and then putting all of that money into stocks for the next 15 years.

But no one knows what stocks will return going forward, so there's a certain measure of guess work involved.

A huge part of this decision comes down to your aversion to debt, if any, and willingness to take on risks. Personally, my wife and I hate debt and are aggressively paying off our 15 year mortgage. Once it's repaid, we'll move all of that money toward investments. I know this is likely to end up being sub-optimal with regard to our net worth, but I'm okay with that.

Do what will make you feel most comfortable. There isn't a definitive right or wrong answer here.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Buying a house, 15yr vs 30yr loan?

Post by ivk5 » Thu Feb 01, 2018 12:56 am

Nothing wrong with paying a premium for liquidity imho, esp while NW relatively low. (Extension of same reason to have a mortgage in the first place.)

In case of prolonged unemployment or similar need, much easier to temporarily stop contributions to taxable acct - or even to dip into taxable acct if EF is exhausted - than to refinance with back against the wall.

Of course requires discipline as others have noted to make sure the liquidity isn't squandered on excess house or living expenses.

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