Pay off a 30 year mortgage in 15 years? The cost of flexibility

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willthrill81
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Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by willthrill81 » Thu Jan 10, 2019 1:01 pm

This post does not address the value in paying off a mortgage early but rather the choice to specifically take out a 30 year mortgage when one intends to pay it off in 15 years. I've heard people say many times that they were paying off their 30 year mortgage in 15 years, and I've also heard this specifically recommended to others. The reason offered for doing so is flexibility, namely, that if one needs to, they can pay the lower 30 year mortgage payment instead of a higher 15 year mortgage payment. However, what I seldom see discussed when this strategy is offered is the quantifiable cost of doing so in the form of a higher interest rate for a 30 year mortgage rather than a 15 year.

According to Bankrate.com, the 30 year mortgage interest rate as of 1/9/2019 was 5.01%. On this same day, 15 year mortgage rates were 4.07%.

For a $100,000 mortgage paid off in 15 years with a 5.01% interest rate (i.e. paying off a 30 year mortgage in 15 years), the principal and interest payment would be $791.31, and the total interest paid over the 15 years would be $42,435.80. In contrast, the same mortgage paid off in the same time but with a 4.07% interest rate would result in a principal and interest payment of $743.20, and the total interest paid would be $33,776. That's a difference of $8,659.80 for every $100,000 borrowed.

Granted, the above numbers are nominal, so the inflation-adjusted difference would be smaller than $8,659.80, but the point remains that the financial cost of the flexibility offered by this approach is not trivial. My personal opinion is that the better approach is to take out a 15 year mortgage and build up an adequate emergency fund to the point that you're very unlikely to genuinely need the smaller 30 year mortgage payment.
“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

mhalley
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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by mhalley » Thu Jan 10, 2019 1:07 pm

You do pay a cost for the flexibility. They are not talked about/promoted as often as 15 and 30 year mortgages, but there are other periods available, 10 year, 20 year, etc.
I came accross this interesting statistic:
Of all home mortgages, 90 % are 30 year, 6% 15 year, and only 2% the other. 12% are cash!
Last edited by mhalley on Thu Jan 10, 2019 1:18 pm, edited 2 times in total.

Thegame14
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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by Thegame14 » Thu Jan 10, 2019 1:09 pm

I have been wondering, let's say you take out a 30 year mortgage putting 20% down and then you are halfway through your mortgage. Assuming interest rates are similar to when you took out the original loan, does it make sense to then go to the bank and take out a 15 year mortgage? Same concept if you are 10 years into a 30 year mortgage, does it make sense to go to bank and ask to take out a 20 year mortgage instead?

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by stoptothink » Thu Jan 10, 2019 1:10 pm

mhalley wrote:
Thu Jan 10, 2019 1:07 pm
You do pay a cost for the flexibility. They are not talked about/promoted as often as 15 and 30 year mortgages, but there are other periods available, 10 year, 20 year, etc.
Really wish we would have taken out a 10yr or maybe even an ARM. We did a 15yr to give us the "flexibility" (my best friend, a real estate developer and mortgage broker tried to talk us into a 30yr for even more "flexibility"), but now we're on pace to have it paid off in 6.

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by mhalley » Thu Jan 10, 2019 1:12 pm

It will depend on closing costs and mortgage rates. You wouldn’t want to extend the overall term, but if you kept it overall the same and got a lower interest rate it could pay off in the long run. They have breakeven calculators for this situation.
https://www.bankrate.com/calculators/mo ... lator.aspx

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by HEDGEFUNDIE » Thu Jan 10, 2019 1:16 pm

Thegame14 wrote:
Thu Jan 10, 2019 1:09 pm
I have been wondering, let's say you take out a 30 year mortgage putting 20% down and then you are halfway through your mortgage. Assuming interest rates are similar to when you took out the original loan, does it make sense to then go to the bank and take out a 15 year mortgage? Same concept if you are 10 years into a 30 year mortgage, does it make sense to go to bank and ask to take out a 20 year mortgage instead?
Assuming no closing costs and the same interest rate, they will be the same.

But of course the interest rate may be lower, and closing costs will exist, so you have to do the math.

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by Rupert » Thu Jan 10, 2019 1:17 pm

mhalley wrote:
Thu Jan 10, 2019 1:12 pm
It will depend on closing costs and mortgage rates.
That, and I think the strategy (taking a 30 for flexibility) is often recommended to people who can just barely afford the 15-year (i.e., it would be a stretch for them) or maybe work in a field (e.g., sales) in which income is variable.

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by LiterallyIronic » Thu Jan 10, 2019 1:25 pm

willthrill81 wrote:
Thu Jan 10, 2019 1:01 pm
For a $100,000 mortgage paid off in 15 years with a 5.01% interest rate (i.e. paying off a 30 year mortgage in 15 years), the principal and interest payment would be $791.31, and the total interest paid over the 15 years would be $42,435.80. In contrast, the same mortgage paid off in the same time but with a 4.07% interest rate would result in a principal and interest payment of $743.20, and the total interest paid would be $33,776. That's a difference of $8,659.80 for every $100,000 borrowed.
I didn't actually crunch the numbers, but this is what did (and are doing). Took a 30-year mortgage in September 2017. Every payment since then has had extra principal with it. Every month, I look at the itemized payment and see how much the interest is. Then I subtract the principal amount from the interest amount to determine how much more is normally being paid in interest than in principal. Then we pay that much extra in principal - we always pay slightly more in principal than in interest. At the beginning of our loan, that amount was an extra $265/month. Now it's down to an extra $216. But we will always pay at least an extra $200/month. The goal is to have it paid off in 15-17 years. Not sure what the 15-year rate was in September 2017, but we got a 30-year for 3.875%, but it would be interesting to find out so I could calculate how much, exactly, we're paying for the flexibility.

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by Admiral » Thu Jan 10, 2019 1:36 pm

Your analysis is fine but what it's missing is that rates move constantly. Sure, one can choose 30 vs 15 when buying, and the rates will be what they are, currently 1% lower (more or less).

But the real key to saving money is to get the 15 when rates have dropped substantially (that is, refinance). For example, I had a 30 yr fixed at 4%, which I was maybe 2 years into. A great rate. But in late 2016 I went to a 15 yr @ 2.25%. The 1.75% difference meant the payment was only $400 more per month to cut the mortgage in half (more or less). But the real difference was in the amount of principal in each payment. IIRC, it went from 2/3 interest and 1/3 principal on the 30 year to the reverse on the 15: 2/3 principal 1/3 interest. And this is at the START of the loan.

Yes, you pay more, but all that money (and then some) is building equity, not going to interest. The rule of thumb is to refinance when the rate spread is 1% or greater. But the greater the spread, the better the 15 year looks.

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by KlangFool » Thu Jan 10, 2019 1:40 pm

willthrill81 wrote:
Thu Jan 10, 2019 1:01 pm

According to Bankrate.com, the 30 year mortgage interest rate as of 1/9/2019 was 5.01%. On this same day, 15 year mortgage rates were 4.07%.
willthrill81,

The answer is highly dependent on the specific circumstances. In my case, it was

A) 30 years at 3.49%

B) 15 years at 3.00%

It was close to a no-brainer to go with 30 years. There was a calculator somewhere tells me that I need to earn about 5% to beat the difference.

KlangFool

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by greg24 » Thu Jan 10, 2019 1:46 pm

Which is why we went with the 10 year.

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by beserker » Thu Jan 10, 2019 1:49 pm

I started out in 2009 with 30 year mortgage at 4.5% after having paid 1 point to go from 4.75%. I was just getting married and I was scared of what I could afford. After having accumulated some emergency funds, with 2nd kid on the way, I figured I needed to get rid of the mortgage so I can pay for kids college when the time comes. I don't expect I will be able to pay both the mortgage and their college tuition. So I went with 15 year term, which btw, it was 2.75% at the time. I could have gone with 30 year at 3.25% (my coworker did who refinanced at the same time as I), but there was about $100-$150 additional interest payment/month I had to make. To me, it was going to be a discipline to get it done, but I felt comfortable with the emergency money I had saved to make that choice. My coworker wanted the flexibility because he had not saved up the rainy day fund and his kids were going to college sooner than mine, so he felt the need for the flexibility, but while he could, his plan was to pay it like it was 15 year mortgage, but if the need arises, he can assume the 30 year payment.

It's your choice based on your situation. Personally, I'm glad I did the 15 years, I was not making much dent on the principal with 30 year payment. Now with 15 year payment, good chunk of it goes into building my asset.

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by health teacher » Thu Jan 10, 2019 1:55 pm

I'm doing a 20 year loan on our new house. Analyzing everything seemed like a never ending cycle, so I went 20 years as a sort of happy medium, financially and emotionally.

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by DrGoogle2017 » Thu Jan 10, 2019 1:57 pm

I did this trade off and glad I did. But I never expect any free lunch, why do people assume there’s should be a free lunch?

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by Colorado13 » Thu Jan 10, 2019 2:01 pm

mhalley wrote:
Thu Jan 10, 2019 1:07 pm
You do pay a cost for the flexibility. They are not talked about/promoted as often as 15 and 30 year mortgages, but there are other periods available, 10 year, 20 year, etc.
I came accross this interesting statistic:
Of all home mortgages, 90 % are 30 year, 6% 15 year, and only 2% the other. 12% are cash!
Total = 110%?

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by Admiral » Thu Jan 10, 2019 2:02 pm

beserker wrote:
Thu Jan 10, 2019 1:49 pm
I started out in 2009 with 30 year mortgage at 4.5% after having paid 1 point to go from 4.75%. I was just getting married and I was scared of what I could afford. After having accumulated some emergency funds, with 2nd kid on the way, I figured I needed to get rid of the mortgage so I can pay for kids college when the time comes. I don't expect I will be able to pay both the mortgage and their college tuition. So I went with 15 year term, which btw, it was 2.75% at the time. I could have gone with 30 year at 3.25% (my coworker did who refinanced at the same time as I), but there was about $100-$150 additional interest payment/month I had to make. To me, it was going to be a discipline to get it done, but I felt comfortable with the emergency money I had saved to make that choice. My coworker wanted the flexibility because he had not saved up the rainy day fund and his kids were going to college sooner than mine, so he felt the need for the flexibility, but while he could, his plan was to pay it like it was 15 year mortgage, but if the need arises, he can assume the 30 year payment.

It's your choice based on your situation. Personally, I'm glad I did the 15 years, I was not making much dent on the principal with 30 year payment. Now with 15 year payment, good chunk of it goes into building my asset.
Yes. And your post points to another factor: when you need this expense to go away, be that college, retirement, etc. I made the decision that I wanted my mortgage gone when I hit FIRE. It will be, or will be low enough so that I can pay it off in a lump sum. For a young person starting out, a 30 year is often the better choice. Once middle age and max earning years set it, the choices are different.

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by Snowjob » Thu Jan 10, 2019 2:03 pm

I went with a 15 vs a 30 and also made a substantial down payment.

Made a nice big down payment when the market was basically its all time high -- effectively taking money off the table. The interest:principal ratio for each payment I make at this point is quite low so the leverage I'm gaining via the mortgage is not expensive and the total value of the loan is not outrageous. No decision is made in a vacuum and given the market run up since 09 and the direction of central bank policy, I am betting for more muted returns over the next decade. If that turns out to be the case, the large down payment and the 15 year mortgage will have been a good move. I cant recall what the break even rate of return was but I did spend a fair amount of time running through scenarios and I'm satisfied with my decision.

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by ivk5 » Thu Jan 10, 2019 2:07 pm

Colorado13 wrote:
Thu Jan 10, 2019 2:01 pm
mhalley wrote:
Thu Jan 10, 2019 1:07 pm
You do pay a cost for the flexibility. They are not talked about/promoted as often as 15 and 30 year mortgages, but there are other periods available, 10 year, 20 year, etc.
I came accross this interesting statistic:
Of all home mortgages, 90 % are 30 year, 6% 15 year, and only 2% the other. 12% are cash!
Total = 110%?
Not to mention, what’s a cash mortgage?

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by delamer » Thu Jan 10, 2019 2:10 pm

Colorado13 wrote:
Thu Jan 10, 2019 2:01 pm
mhalley wrote:
Thu Jan 10, 2019 1:07 pm
You do pay a cost for the flexibility. They are not talked about/promoted as often as 15 and 30 year mortgages, but there are other periods available, 10 year, 20 year, etc.
I came accross this interesting statistic:
Of all home mortgages, 90 % are 30 year, 6% 15 year, and only 2% the other. 12% are cash!
Total = 110%?
And all cash means no mortgage.

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by sf_tech_saver » Thu Jan 10, 2019 2:12 pm

You could also add to the calculation that one gets pretty great discounts taking out 7 year ARMs as well -- 3.5-3.7% right now. If your portfolio is sufficient to pay off the mortgage comfortably why not take a look at these rates as well?

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by delamer » Thu Jan 10, 2019 2:17 pm

I’d guess that the overwhelming majority of people who take a 30 year mortgage couldn’t qualified to buy the same property with a shorter-term loan. But that isn’t the issue raised in the thread...

If I was concerned about flexibility, I think a cost of less than $600/year (in nominal dollars over a 15 year period) per $100K — which is based on the OP’s example — would be a reasonable price to pay.

As someone said earlier, there is no free lunch.

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by Admiral » Thu Jan 10, 2019 2:23 pm

delamer wrote:
Thu Jan 10, 2019 2:17 pm
I’d guess that the overwhelming majority of people who take a 30 year mortgage couldn’t qualified to buy the same property with a shorter-term loan. But that isn’t the issue raised in the thread...

If I was concerned about flexibility, I think a cost of less than $600/year (in nominal dollars over a 15 year period) per $100K — which is based on the OP’s example — would be a reasonable price to pay.

As someone said earlier, there is no free lunch.
I'd venture to guess most people on the board borrow twice or three times the $100k in the example. That's the reality. It's significant money.

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by Thegame14 » Thu Jan 10, 2019 2:35 pm

.....now I want a free lunch....

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by SubieGirl14 » Thu Jan 10, 2019 2:46 pm

Our first mortgage was a 15 year at 2.875% and we were almost 5 years in when we sold and relocated. We took out a higher mortgage when we relocated, almost twice the previous mortgage and decided to go with a 30 year at 4% just in case anything happened cash flow wise. A couple of months into the mortgage, we realized that we did not want to have a mortgage into our 70's. We started paying it like a 15 year but it annoyed me that we were paying the higher interest rate.

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by delamer » Thu Jan 10, 2019 3:03 pm

Admiral wrote:
Thu Jan 10, 2019 2:23 pm
delamer wrote:
Thu Jan 10, 2019 2:17 pm
I’d guess that the overwhelming majority of people who take a 30 year mortgage couldn’t qualified to buy the same property with a shorter-term loan. But that isn’t the issue raised in the thread...

If I was concerned about flexibility, I think a cost of less than $600/year (in nominal dollars over a 15 year period) per $100K — which is based on the OP’s example — would be a reasonable price to pay.

As someone said earlier, there is no free lunch.
I'd venture to guess most people on the board borrow twice or three times the $100k in the example. That's the reality. It's significant money.
Yes, most people are going to borrow more than $100K. But don’t forget that the OP’s proposal is to take the 15 year loan and create a large emergency fund to cover the difference in payments. So the more borrowed, the larger the emergency fund needed. That too can be significant money.

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by Admiral » Thu Jan 10, 2019 3:14 pm

delamer wrote:
Thu Jan 10, 2019 3:03 pm
Admiral wrote:
Thu Jan 10, 2019 2:23 pm
delamer wrote:
Thu Jan 10, 2019 2:17 pm
I’d guess that the overwhelming majority of people who take a 30 year mortgage couldn’t qualified to buy the same property with a shorter-term loan. But that isn’t the issue raised in the thread...

If I was concerned about flexibility, I think a cost of less than $600/year (in nominal dollars over a 15 year period) per $100K — which is based on the OP’s example — would be a reasonable price to pay.

As someone said earlier, there is no free lunch.
I'd venture to guess most people on the board borrow twice or three times the $100k in the example. That's the reality. It's significant money.
Yes, most people are going to borrow more than $100K. But don’t forget that the OP’s proposal is to take the 15 year loan and create a large emergency fund to cover the difference in payments. So the more borrowed, the larger the emergency fund needed. That too can be significant money.
That approach (what OP posted) is counter-intuitive. He's saying one should both pay more each month (ie have a 15 year note) AND also save more in an emergency fund. That's more money on both ends. One could counter that by saying that one could get a 30 year, sock away the extra money one is not paying each month, and then pay off the loan early (though likely not 15 years early.)

Most people don't stay in the same house with the same loan for 30 years. The average is 7 years. It's in middle age where people begin to say "hey, this is my forever house, my kids will be gone soon, I'm thinking about retiring, my income is steady, etc." So in these cases a shorter term loan usually makes a lot of sense, provided the payments are affordable/cashflow allows. 22 year olds buying their starter home are less likely to need/want/be able to afford a short-term note.

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by delamer » Thu Jan 10, 2019 3:37 pm

Admiral wrote:
Thu Jan 10, 2019 3:14 pm
delamer wrote:
Thu Jan 10, 2019 3:03 pm
Admiral wrote:
Thu Jan 10, 2019 2:23 pm
delamer wrote:
Thu Jan 10, 2019 2:17 pm
I’d guess that the overwhelming majority of people who take a 30 year mortgage couldn’t qualified to buy the same property with a shorter-term loan. But that isn’t the issue raised in the thread...

If I was concerned about flexibility, I think a cost of less than $600/year (in nominal dollars over a 15 year period) per $100K — which is based on the OP’s example — would be a reasonable price to pay.

As someone said earlier, there is no free lunch.
I'd venture to guess most people on the board borrow twice or three times the $100k in the example. That's the reality. It's significant money.
Yes, most people are going to borrow more than $100K. But don’t forget that the OP’s proposal is to take the 15 year loan and create a large emergency fund to cover the difference in payments. So the more borrowed, the larger the emergency fund needed. That too can be significant money.
That approach (what OP posted) is counter-intuitive. He's saying one should both pay more each month (ie have a 15 year note) AND also save more in an emergency fund. That's more money on both ends. One could counter that by saying that one could get a 30 year, sock away the extra money one is not paying each month, and then pay off the loan early (though likely not 15 years early.)
I’d say not only counterintuitive, but not realistic for most people/families because it is a double hit on cash flow. A larger payment and a larger contribution to the emergency fund is required.

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by hand » Thu Jan 10, 2019 3:43 pm

delamer wrote:
Thu Jan 10, 2019 2:17 pm
I’d guess that the overwhelming majority of people who take a 30 year mortgage couldn’t qualified to buy the same property with a shorter-term loan. But that isn’t the issue raised in the thread...

If I was concerned about flexibility, I think a cost of less than $600/year (in nominal dollars over a 15 year period) per $100K — which is based on the OP’s example — would be a reasonable price to pay.

As someone said earlier, there is no free lunch.
To further refine this point, conceptually the $600/yr is spread across several benefits:
1) Flexibilty
2) Insurance against unexpected inflation
3) "Safe" (non-callable) leverage amplifying investment returns assuming positive returns over the 15 years in question

While it is certaintly possible to come out on the wrong side of this bet in a period of deflationary / negative returns, one would think the Expected Value of this approach is significantly positive.

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by Texanbybirth » Thu Jan 10, 2019 3:57 pm

hand wrote:
Thu Jan 10, 2019 3:43 pm
delamer wrote:
Thu Jan 10, 2019 2:17 pm
I’d guess that the overwhelming majority of people who take a 30 year mortgage couldn’t qualified to buy the same property with a shorter-term loan. But that isn’t the issue raised in the thread...

If I was concerned about flexibility, I think a cost of less than $600/year (in nominal dollars over a 15 year period) per $100K — which is based on the OP’s example — would be a reasonable price to pay.

As someone said earlier, there is no free lunch.
To further refine this point, conceptually the $600/yr is spread across several benefits:
1) Flexibilty
2) Insurance against unexpected inflation
3) "Safe" (non-callable) leverage amplifying investment returns assuming positive returns over the 15 years in question

While it is certaintly possible to come out on the wrong side of this bet in a period of deflationary / negative returns, one would think the Expected Value of this approach is significantly positive.
Very interesting thread.

I think those are the reasons we went with a 30-yr? Really at the time the 15-yr pmt wasn't feasible (ouch, as a Dave Ramsey devotee), and now 3.5 yrs in the payments are shrinking as a % of take home pay - the breathing room is nice. We do put money aside in various savings accounts, and I like the approach of looking at those accounts in 10-15 years to see if they could be used to just drop the mortgage in one fell swoop. However, with 3 little kids I'm guessing something will come up between now and then. I guess we also could have reduced my 401(k) contribution down from 15%, but my wife is actually way more hesitant to do that than I am. She's a dreamer and hopes I can retire someday, God love her. :D
"Knowledge and innocence are both excellent things, and they are both very funny. But it is right that knowledge should be the servant and innocence the master." - GK Chesterton

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by Ben Mathew » Thu Jan 10, 2019 4:09 pm

willthrill81 wrote:
Thu Jan 10, 2019 1:01 pm
For a $100,000 mortgage paid off in 15 years with a 5.01% interest rate (i.e. paying off a 30 year mortgage in 15 years), the principal and interest payment would be $791.31, and the total interest paid over the 15 years would be $42,435.80. In contrast, the same mortgage paid off in the same time but with a 4.07% interest rate would result in a principal and interest payment of $743.20, and the total interest paid would be $33,776. That's a difference of $8,659.80 for every $100,000 borrowed.
Another point to note: if money gets tight and you end up "exercising the option" and switch to the 30 year term, the monthly payment drops to $537.43. Compared to the $743.20 for the 15 year @4.07%, that's only a reduction of $205.77. In other words, you're paying $48.11 per month extra to maintain the option of reducing your monthly payments by $205.77 for the remainder of your mortgage term. That seems very expensive to me.

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by HEDGEFUNDIE » Thu Jan 10, 2019 4:22 pm

hand wrote:
Thu Jan 10, 2019 3:43 pm
delamer wrote:
Thu Jan 10, 2019 2:17 pm
I’d guess that the overwhelming majority of people who take a 30 year mortgage couldn’t qualified to buy the same property with a shorter-term loan. But that isn’t the issue raised in the thread...

If I was concerned about flexibility, I think a cost of less than $600/year (in nominal dollars over a 15 year period) per $100K — which is based on the OP’s example — would be a reasonable price to pay.

As someone said earlier, there is no free lunch.
To further refine this point, conceptually the $600/yr is spread across several benefits:
1) Flexibilty
2) Insurance against unexpected inflation
3) "Safe" (non-callable) leverage amplifying investment returns assuming positive returns over the 15 years in question

While it is certaintly possible to come out on the wrong side of this bet in a period of deflationary / negative returns, one would think the Expected Value of this approach is significantly positive.
When I took out my $1M mortgage last year the rate difference between a normal amortizing 5/1 ARM and an interest-only 5/1 ARM was 0.1%, or $1,000/yr.

I went with the amortizing loan but now I wonder if that was the right decision.

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by Starfish » Thu Jan 10, 2019 4:37 pm

If the interest rates are high the payment is dominated by the interest and you see a large difference with interest change.
Not long ago the interest rates where significantly lower and also the difference between interest rates was smaller.
For less than 10% difference between monthly payments it's no brainer to chose the 15y mortgage. If the difference was 50% or more the discussion would have been very different. Especially when you invest the difference in payments.

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by willthrill81 » Thu Jan 10, 2019 4:53 pm

Ben Mathew wrote:
Thu Jan 10, 2019 4:09 pm
willthrill81 wrote:
Thu Jan 10, 2019 1:01 pm
For a $100,000 mortgage paid off in 15 years with a 5.01% interest rate (i.e. paying off a 30 year mortgage in 15 years), the principal and interest payment would be $791.31, and the total interest paid over the 15 years would be $42,435.80. In contrast, the same mortgage paid off in the same time but with a 4.07% interest rate would result in a principal and interest payment of $743.20, and the total interest paid would be $33,776. That's a difference of $8,659.80 for every $100,000 borrowed.
Another point to note: if money gets tight and you end up "exercising the option" and switch to the 30 year term, the monthly payment drops to $537.43. Compared to the $743.20 for the 15 year @4.07%, that's only a reduction of $205.77. In other words, you're paying $48.11 per month extra to maintain the option of reducing your monthly payments by $205.77 for the remainder of your mortgage term. That seems very expensive to me.
Precisely. I just don't see the mathematical benefit from standpoint of paying a higher interest rate just for the sake of flexibility. If you're doing it because you want leverage or as a hedge against inflation, that's different.
“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: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by willthrill81 » Thu Jan 10, 2019 4:55 pm

delamer wrote:
Thu Jan 10, 2019 3:37 pm
Admiral wrote:
Thu Jan 10, 2019 3:14 pm
delamer wrote:
Thu Jan 10, 2019 3:03 pm
Admiral wrote:
Thu Jan 10, 2019 2:23 pm
delamer wrote:
Thu Jan 10, 2019 2:17 pm
I’d guess that the overwhelming majority of people who take a 30 year mortgage couldn’t qualified to buy the same property with a shorter-term loan. But that isn’t the issue raised in the thread...

If I was concerned about flexibility, I think a cost of less than $600/year (in nominal dollars over a 15 year period) per $100K — which is based on the OP’s example — would be a reasonable price to pay.

As someone said earlier, there is no free lunch.
I'd venture to guess most people on the board borrow twice or three times the $100k in the example. That's the reality. It's significant money.
Yes, most people are going to borrow more than $100K. But don’t forget that the OP’s proposal is to take the 15 year loan and create a large emergency fund to cover the difference in payments. So the more borrowed, the larger the emergency fund needed. That too can be significant money.
That approach (what OP posted) is counter-intuitive. He's saying one should both pay more each month (ie have a 15 year note) AND also save more in an emergency fund. That's more money on both ends. One could counter that by saying that one could get a 30 year, sock away the extra money one is not paying each month, and then pay off the loan early (though likely not 15 years early.)
I’d say not only counterintuitive, but not realistic for most people/families because it is a double hit on cash flow. A larger payment and a larger contribution to the emergency fund is required.
It's not necessarily counter-intuitive at all. Yes, it's going to take longer to build up any emergency fund if you have higher mortgage payments, but it still can and should be done. The standard advice is to have an EF of 3-6 months of expenses, and I believe that for the overwhelming majority of people, that's sufficient, whether they have a 15 or 30 year mortgage. Naturally, the EF of someone with a 15 year mortgage will need to be larger than someone with a 30 year as a natural consequence of higher monthly expenditures.
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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by cherijoh » Thu Jan 10, 2019 5:13 pm

willthrill81 wrote:
Thu Jan 10, 2019 1:01 pm
This post does not address the value in paying off a mortgage early but rather the choice to specifically take out a 30 year mortgage when one intends to pay it off in 15 years. I've heard people say many times that they were paying off their 30 year mortgage in 15 years, and I've also heard this specifically recommended to others. The reason offered for doing so is flexibility, namely, that if one needs to, they can pay the lower 30 year mortgage payment instead of a higher 15 year mortgage payment. However, what I seldom see discussed when this strategy is offered is the quantifiable cost of doing so in the form of a higher interest rate for a 30 year mortgage rather than a 15 year.

According to Bankrate.com, the 30 year mortgage interest rate as of 1/9/2019 was 5.01%. On this same day, 15 year mortgage rates were 4.07%.

For a $100,000 mortgage paid off in 15 years with a 5.01% interest rate (i.e. paying off a 30 year mortgage in 15 years), the principal and interest payment would be $791.31, and the total interest paid over the 15 years would be $42,435.80. In contrast, the same mortgage paid off in the same time but with a 4.07% interest rate would result in a principal and interest payment of $743.20, and the total interest paid would be $33,776. That's a difference of $8,659.80 for every $100,000 borrowed.

Granted, the above numbers are nominal, so the inflation-adjusted difference would be smaller than $8,659.80, but the point remains that the financial cost of the flexibility offered by this approach is not trivial. My personal opinion is that the better approach is to take out a 15 year mortgage and build up an adequate emergency fund to the point that you're very unlikely to genuinely need the smaller 30 year mortgage payment.
The last part of your post is a conundrum. If you get a 15-yr mortgage instead of a 30-yr mortgage (on the same house) you will have less cash flow to build up that emergency fund which permits you to afford the 15-yr mortgage. What you actually need to do if you want to save this non-trivial cost is to buy a house that you can afford on a 15-yr mortgage!

I took out a 30-yr mortgage in 1992 when interest rates were 7.75%. At that time the differential between 15- and 30-yr mortgages was a lot smaller - IIRC ~0.375%. I was having trouble selling my condo, so it was fortunate that I didn't go with the 15-yr mortgage because bad tenants/broken leases meant that I was covering both mortgages without rental income far more often than I would have liked!!

In the late '90s (after selling the condo), I refinanced to a 6.25% rate and a 15-yr term and then a few years after that I got a 10-yr mortgage at 5.25%. I ended up paying off my mortgage in just over 21 years.

I would recommend making sure that you can truly afford the 15-yr payments, otherwise you may find yourself doing the exact opposite of me - going from a 15-yr mortgage to a 30-yr mortgage in a rising interest environment!!

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by michaeljc70 » Thu Jan 10, 2019 6:20 pm

If there wasn't a cost of flexibility, everyone would take a 30 year. In my opinion, unless you are starting out with a first home and things are tight, if you need that flexibility maybe you are overbuying. I'm happy with my 15 year 3.4% loan. I also think there has to be some behavioral science reasons to take the 15 year. I can see people with 30 years saying I can pay an extra $600 on the mortgage this month or use it for (vacation|a new car|whatever). With the 15 year there is no temptation (unless you want to default).

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by willthrill81 » Thu Jan 10, 2019 7:25 pm

cherijoh wrote:
Thu Jan 10, 2019 5:13 pm
The last part of your post is a conundrum. If you get a 15-yr mortgage instead of a 30-yr mortgage (on the same house) you will have less cash flow to build up that emergency fund which permits you to afford the 15-yr mortgage.
I addressed that point in this post already.
willthrill81 wrote:
Thu Jan 10, 2019 4:55 pm
Yes, it's going to take longer to build up any emergency fund if you have higher mortgage payments, but it still can and should be done. The standard advice is to have an EF of 3-6 months of expenses, and I believe that for the overwhelming majority of people, that's sufficient, whether they have a 15 or 30 year mortgage. Naturally, the EF of someone with a 15 year mortgage will need to be larger than someone with a 30 year as a natural consequence of higher monthly expenditures.
cherijoh wrote:
Thu Jan 10, 2019 5:13 pm
What you actually need to do if you want to save this non-trivial cost is to buy a house that you can afford on a 15-yr mortgage!
I entirely agree.
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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by JGoneRiding » Thu Jan 10, 2019 10:27 pm

willthrill81 wrote:
Thu Jan 10, 2019 4:53 pm
Ben Mathew wrote:
Thu Jan 10, 2019 4:09 pm
willthrill81 wrote:
Thu Jan 10, 2019 1:01 pm
For a $100,000 mortgage paid off in 15 years with a 5.01% interest rate (i.e. paying off a 30 year mortgage in 15 years), the principal and interest payment would be $791.31, and the total interest paid over the 15 years would be $42,435.80. In contrast, the same mortgage paid off in the same time but with a 4.07% interest rate would result in a principal and interest payment of $743.20, and the total interest paid would be $33,776. That's a difference of $8,659.80 for every $100,000 borrowed.
Another point to note: if money gets tight and you end up "exercising the option" and switch to the 30 year term, the monthly payment drops to $537.43. Compared to the $743.20 for the 15 year @4.07%, that's only a reduction of $205.77. In other words, you're paying $48.11 per month extra to maintain the option of reducing your monthly payments by $205.77 for the remainder of your mortgage term. That seems very expensive to me.
Precisely. I just don't see the mathematical benefit from standpoint of paying a higher interest rate just for the sake of flexibility. If you're doing it because you want leverage or as a hedge against inflation, that's different.
You are both ignoring the fact that an "average" house is going to be more like 250k. So more like a $500 / month difference and that can be very significant to most budgets

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by Mako52 » Thu Jan 10, 2019 10:55 pm

Admiral wrote:
Thu Jan 10, 2019 1:36 pm
Your analysis is fine but what it's missing is that rates move constantly. Sure, one can choose 30 vs 15 when buying, and the rates will be what they are, currently 1% lower (more or less).

But the real key to saving money is to get the 15 when rates have dropped substantially (that is, refinance). For example, I had a 30 yr fixed at 4%, which I was maybe 2 years into. A great rate. But in late 2016 I went to a 15 yr @ 2.25%. The 1.75% difference meant the payment was only $400 more per month to cut the mortgage in half (more or less). But the real difference was in the amount of principal in each payment. IIRC, it went from 2/3 interest and 1/3 principal on the 30 year to the reverse on the 15: 2/3 principal 1/3 interest. And this is at the START of the loan.

Yes, you pay more, but all that money (and then some) is building equity, not going to interest. The rule of thumb is to refinance when the rate spread is 1% or greater. But the greater the spread, the better the 15 year looks.
Spot on. But that 15 year at 2.25 was super cheap. In summer 2016 we were very close to going from from a 4.125/30 to a 3.375/20. 2.25/15 wasn't even on our radar. Right now a 15 year is near our current 4.125.

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by willthrill81 » Thu Jan 10, 2019 11:54 pm

JGoneRiding wrote:
Thu Jan 10, 2019 10:27 pm
willthrill81 wrote:
Thu Jan 10, 2019 4:53 pm
Ben Mathew wrote:
Thu Jan 10, 2019 4:09 pm
willthrill81 wrote:
Thu Jan 10, 2019 1:01 pm
For a $100,000 mortgage paid off in 15 years with a 5.01% interest rate (i.e. paying off a 30 year mortgage in 15 years), the principal and interest payment would be $791.31, and the total interest paid over the 15 years would be $42,435.80. In contrast, the same mortgage paid off in the same time but with a 4.07% interest rate would result in a principal and interest payment of $743.20, and the total interest paid would be $33,776. That's a difference of $8,659.80 for every $100,000 borrowed.
Another point to note: if money gets tight and you end up "exercising the option" and switch to the 30 year term, the monthly payment drops to $537.43. Compared to the $743.20 for the 15 year @4.07%, that's only a reduction of $205.77. In other words, you're paying $48.11 per month extra to maintain the option of reducing your monthly payments by $205.77 for the remainder of your mortgage term. That seems very expensive to me.
Precisely. I just don't see the mathematical benefit from standpoint of paying a higher interest rate just for the sake of flexibility. If you're doing it because you want leverage or as a hedge against inflation, that's different.
You are both ignoring the fact that an "average" house is going to be more like 250k. So more like a $500 / month difference and that can be very significant to most budgets
We're not ignoring it. All of these numbers have been in relation to a $100k mortgage for the sake of comparison. You're exactly right that $500 is probably much nearer the average difference, and that is indeed significant. It's enough to completely fund an IRA.
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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by JDDS » Fri Jan 11, 2019 3:58 am

TFB wrote an article several years ago with the same points
https://thefinancebuff.com/payment-flex ... edule.html

I like the fact he labels it insurance because it mentally made me think about it differently.

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by willthrill81 » Fri Jan 11, 2019 10:16 am

JDDS wrote:
Fri Jan 11, 2019 3:58 am
TFB wrote an article several years ago with the same points
https://thefinancebuff.com/payment-flex ... edule.html

I like the fact he labels it insurance because it mentally made me think about it differently.
Thanks. From that post,
I don’t think the cost is worth it. There are other better ways to deal with a temporary cash crunch. Beef up your investments and emergency fund. Be willing to cut back on other expenses if a temporary cash crunch develops.
emphasis added

Apparently, I'm not the only one who thinks that beefing up your EF is a better choice. Yes, it will take longer since you have less cash flow, but it can and probably should still be done. If doing so enables you to safe significant mortgage interest, the effective return on your additional emergency funds could be significant.
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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by Ben Mathew » Fri Jan 11, 2019 2:39 pm

willthrill81 wrote:
Fri Jan 11, 2019 10:16 am
Apparently, I'm not the only one who thinks that beefing up your EF is a better choice. Yes, it will take longer since you have less cash flow, but it can and probably should still be done. If doing so enables you to safe significant mortgage interest, the effective return on your additional emergency funds could be significant.
"Effective return on your additional emergency funds" is a good way to think about it. Here's a quick calculation:

The potential payment reduction is $205.77/month. If you use the payment reduction option for three years, that works out to $7,407.72.

Suppose you save the $7,407.72 in your emergency fund instead, and that enables you to take out the 15 year mortgage @ 4.07%. That would save you you $48.11/month = $577.32/year. That's a return of $577.32/$7,407.72 = 7.8% per year for fifteen years.

If instead you want to save 7 years worth of reduced payments, you would need to save $17,284.68 in the emergency fund. The rate of return drops to $577.32/$17,284.68 = 3.3% per year for fifteen years. Still, substantial.

And finally, if you save up for all fifteen years of reduced payments ($37,038.60), you'd be looking at an excess return of $577.32/$37,038.60 = 1.6% per year.

And remember, these are excess returns in addition to the normal rate of return you get on your emergency fund.

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by willthrill81 » Fri Jan 11, 2019 8:18 pm

Ben Mathew wrote:
Fri Jan 11, 2019 2:39 pm
willthrill81 wrote:
Fri Jan 11, 2019 10:16 am
Apparently, I'm not the only one who thinks that beefing up your EF is a better choice. Yes, it will take longer since you have less cash flow, but it can and probably should still be done. If doing so enables you to safe significant mortgage interest, the effective return on your additional emergency funds could be significant.
"Effective return on your additional emergency funds" is a good way to think about it. Here's a quick calculation:

The potential payment reduction is $205.77/month. If you use the payment reduction option for three years, that works out to $7,407.72.

Suppose you save the $7,407.72 in your emergency fund instead, and that enables you to take out the 15 year mortgage @ 4.07%. That would save you you $48.11/month = $577.32/year. That's a return of $577.32/$7,407.72 = 7.8% per year for fifteen years.

If instead you want to save 7 years worth of reduced payments, you would need to save $17,284.68 in the emergency fund. The rate of return drops to $577.32/$17,284.68 = 3.3% per year for fifteen years. Still, substantial.

And finally, if you save up for all fifteen years of reduced payments ($37,038.60), you'd be looking at an excess return of $577.32/$37,038.60 = 1.6% per year.

And remember, these are excess returns in addition to the normal rate of return you get on your emergency fund.
Good analysis. It makes this almost seem like a no brainer unless you're holding the mortgage as a source of leverage or as an inflation hedge.
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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by SovereignInvestor » Fri Jan 11, 2019 10:52 pm

I got a 10/1 ARM at 3.125% January 2018 instead of 30Y fixed at 4.125% or 15Y fixed at 3.75%.

More flexibility than 15Y fixed and lower rate than 30Y.

The issue with 15Y is its so much riskier with higher required payments. With 30Y it's costing a lot of extra interest. Can you do 30Y but buy points to knock down rate?

The ARM with 10 years has interest rate risk, but 10 years is a long time. It depends on interest savings too but saving 1pt a year over 10 years if went to prepay extra makes it very hard to lose since the balance after 10 years would be much lower even if rates rise.

Interest rates would have to rise so much to lose it would be hard for it not to be in a high inflation environment which would make paying the debt easier anyway.

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by willthrill81 » Fri Jan 11, 2019 11:50 pm

SovereignInvestor wrote:
Fri Jan 11, 2019 10:52 pm
The issue with 15Y is its so much riskier with higher required payments.
How much 'riskier' it is is highly dependent on the individual borrower. But if it's truly 'risky' for a borrower to have a 15 year mortgage, I suspect that they're borrowing too much money in the first place.

And don't forget that a mortgage drawn out over 30 years has its own risks as well. It means that there is a 30 year period in which failure to make the required payments results in foreclosure of your home. So there is literally twice as much time in that 'danger zone' as compared to a 15 year mortgage.

25 years ago, Thomas Stanley stated that if you could not afford your mortgage payments if your income was cut in half, then you could not easily afford your home. I think that he was mostly right.
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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by MikeG62 » Sat Jan 12, 2019 6:39 am

Good analysis - compelling reason to take the 15 year.

I’d add one other thing. I’d bet a significant number of folks who take the 30 intending to pay it like a 15 will find excuses along the way to not make the higher mortgage payment. After letting it slide once, they do it a second time and so on and so forth. My point being that many people who employ the “take out a 30 year mortgage and pay it in 15 years” strategy don’t end up close to paying it in 15 years. Boogleheads higher chance of following through on their plan than others, but still not without risk for a sizable number of folks.

When we moved into our current home (17 years ago), we took a 15 year mortgage but planned to make extra principal payments along the way too pay it off more quickly. We refinanced a year after taking the initial mortgage (for a lower interest rate) and end up paying off the mortgage in about 11 years in total. But one has be disciplined about it.
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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by SovereignInvestor » Sat Jan 12, 2019 6:40 am

Yes that depends on the borrower. The counter point is that in years 16 through 30 on the 30Y fixed, the fixed payments adjusted for inflation should be much easier to pay. Assuming 2% annual inflation, the payment 16tg year would be about 25% less adjusted for inflation than first payment and final payment would be nearly half as much in real terms as first.

So yes it's longevity makes it riskier than 15Y but the real value of the payments is likely so low at the end.

If inflation was lower or negative, well then it likely means interest rates will have plummeted so a refi opportunity is in order and having paid off balance slower via 30Y means more interest savings that way.

All of this depends on savings of 15Y versus 30Y. At a certain point if spread is wide enough 15Y become more attractive. But if it is only like 25BP...that's hardlt enough to compensate being forced to make higher payments.

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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by willthrill81 » Sat Jan 12, 2019 10:55 am

MikeG62 wrote:
Sat Jan 12, 2019 6:39 am
I’d add one other thing. I’d bet a significant number of folks who take the 30 intending to pay it like a 15 will find excuses along the way to not make the higher mortgage payment. After letting it slide once, they do it a second time and so on and so forth. My point being that many people who employ the “take out a 30 year mortgage and pay it in 15 years” strategy don’t end up close to paying it in 15 years.
Good point. Paying off a 30 year mortgage in 15 years essentially requires borrowers to make 180 'good' decisions, whereas just taking out the 15 year mortgage in the first place only requires one.
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Re: Pay off a 30 year mortgage in 15 years? The cost of flexibility

Post by Ben Mathew » Sun Jan 13, 2019 11:09 am

The discussion so far does not show that taking out a 30 year mortgage @ 5.01% is a bad idea. Only that paying it off in 15 years, but not availing yourself of the lower 4.07% interest rate is leaving a lot of money on the table.

But if you compare the 15 year and 30 year mortgage when both are held to term, the 30 year mortgage is not necessarily terrible because you get an extra $205.77 in lower monthly payments for the first 15 years that you can invest. If the returns on this investment is high enough, you can come out ahead with the 30 year mortgage.

Monthly contributions to the investment account:
30 year mortgage: $205.77 for 360 months
15 year mortgage: $0 for first 180 months, then $743.20 for the next 180 months.

The breakeven nominal interest rate on the investment account turns out to be 6.6%. If your investment account gets 6.6% nominal, at the end of 360 months (30 years), you would have $224K in the investment account + a paid off mortgage whether you go with the 15 year or the 30 year. If the return is higher, the 30 year mortgage comes out ahead. If the return is lower, the 15 year mortgage wins.

6.6% nominal is a very high target. Bonds won't cut it. Stocks might beat it in expected terms. But it's a severely reduced premium for taking on equity risk. Given these numbers, I would strongly recommend the 15 year mortgage over the 30 year if you can afford it. A risk-free tax-free return of 6.6% nominal for 30 years is not easy to find.

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