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

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills
User avatar
Topic Author
willthrill81
Posts: 13959
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

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

Post by willthrill81 » Sun Jan 13, 2019 11:26 am

Ben Mathew wrote:
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.
Good point. Yes, a 6.6% after-tax nominal return is a high hurdle. And if you add in the fact that most borrowers will have private mortgage insurance for significantly longer with the 30 year mortgage than the 15, that tilts things further toward the 15 year as well.
“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

delamer
Posts: 9324
Joined: Tue Feb 08, 2011 6:13 pm

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

Post by delamer » Sun Jan 13, 2019 2:53 pm

Ben Mathew wrote:
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.
This is helpful, especially given the point that a risk-free 6.6% return is currently not doable. I don’t know how much the tax circumstances of the individual/family making the decision might change the analysis, but two obvious issues are:

1. Is there any tax benefit from the mortgage interest deduction?
2. What taxes are being paid on the earnings on the investments, assuming the account is taxable and some of the return is dividends (and capital gains, if mutual funds)?

dcw213
Posts: 144
Joined: Sun Dec 16, 2012 3:04 pm

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

Post by dcw213 » Sun Jan 13, 2019 3:40 pm

Your cited rates don't seem right. The current difference between 30 and 15 year fixed is closer to 50-60 bps rather than your 100 bps. This changes the economics drastically. At 50 bps I would say the flexibility of the 30 is worth the incremental interest expense. At 100 I would be inclined to go with the 15 year. I say this as someone who plans to buy a home this year and has been weighing this very choice

User avatar
Ben Mathew
Posts: 787
Joined: Tue Mar 13, 2018 11:41 am
Location: Seattle
Contact:

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

Post by Ben Mathew » Sun Jan 13, 2019 3:44 pm

delamer wrote:
Sun Jan 13, 2019 2:53 pm
Ben Mathew wrote:
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.
This is helpful, especially given the point that a risk-free 6.6% return is currently not doable. I don’t know how much the tax circumstances of the individual/family making the decision might change the analysis, but two obvious issues are:

1. Is there any tax benefit from the mortgage interest deduction?
2. What taxes are being paid on the earnings on the investments, assuming the account is taxable and some of the return is dividends (and capital gains, if mutual funds)?
Glad you brought up the tax considerations. Most people won't be able to take the full deduction due to the $24K standard deduction. But as a benchmark, if interest is fully deducted @

0% marginal tax rate, breakeven post-tax nominal return = 6.6% (both accounts will hold $224K)
10% marginal tax rate, breakeven post-tax nominal return = 5.8% (both accounts will hold $223K)
20% marginal tax rate, breakeven post-tax nominal return = 5.1% (both accounts will hold $222K).
30% marginal tax rate, breakeven post-tax nominal return = 4.4% (both accounts will hold $217K).

Since these are the post-tax nominal returns required, it's the return required in tax-advantaged accounts. Taxable accounts will require correspondingly higher returns.

User avatar
Ben Mathew
Posts: 787
Joined: Tue Mar 13, 2018 11:41 am
Location: Seattle
Contact:

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

Post by Ben Mathew » Sun Jan 13, 2019 4:13 pm

dcw213 wrote:
Sun Jan 13, 2019 3:40 pm
Your cited rates don't seem right. The current difference between 30 and 15 year fixed is closer to 50-60 bps rather than your 100 bps. This changes the economics drastically. At 50 bps I would say the flexibility of the 30 is worth the incremental interest expense. At 100 I would be inclined to go with the 15 year. I say this as someone who plans to buy a home this year and has been weighing this very choice
From Wells Fargo mortgage rates, I am currently getting 30 year @ 4.5% and 15 year @ 3.875% for conforming loans, which is closer to the spread you're seeing. Plugging these rates in, I get

30 year @ 4.5%: monthly payment $506.69
15 year @ 3.875%: monthly payment $733.44

The breakeven nominal after tax return required on the investment account is 5.5% (assuming no mortgage tax deductions). Down from 6.6%, but still quite high.

User avatar
Topic Author
willthrill81
Posts: 13959
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

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

Post by willthrill81 » Sun Jan 13, 2019 4:39 pm

dcw213 wrote:
Sun Jan 13, 2019 3:40 pm
Your cited rates don't seem right. The current difference between 30 and 15 year fixed is closer to 50-60 bps rather than your 100 bps. This changes the economics drastically. At 50 bps I would say the flexibility of the 30 is worth the incremental interest expense. At 100 I would be inclined to go with the 15 year. I say this as someone who plans to buy a home this year and has been weighing this very choice
I provided the source of the rates.
“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

petulant
Posts: 751
Joined: Thu Sep 22, 2016 1:09 pm

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

Post by petulant » Sun Jan 13, 2019 5:30 pm

Ben Mathew wrote:
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.
There are good reasons to go with a 30-year mortgage, including being able to invest the payment difference in stocks and the long-term wealth-building inflation hedge/leverage. However, the purpose of the thread was to specifically confront the idea that a person who would otherwise want to take out a 15-year mortgage should take out a 30-year mortgage instead, then make payments to pay off in 15 years. That strategy excludes the use of a 30-year mortgage to invest the difference and benefit from leveraged appreciation over time, since the purchaser is literally trying to get rid of the mortgage in 15 years and direct the ~$200 or whatever to the mortgage. OP shows convincingly that this pro-flexibility strategy is not optimal in all environments, including the current 15-30 spread we observe today.

User avatar
danielc
Posts: 640
Joined: Sun Dec 10, 2017 4:48 am
Location: Iowa, USA
Contact:

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

Post by danielc » Sun Jan 13, 2019 6:32 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!
Those numbers don't add up to 100%.

User avatar
danielc
Posts: 640
Joined: Sun Dec 10, 2017 4:48 am
Location: Iowa, USA
Contact:

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

Post by danielc » Sun Jan 13, 2019 6:36 pm

KlangFool wrote:
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
Can you explain? With the numbers you posted, I would have taken a really serious look at the 15 years.

User avatar
Ben Mathew
Posts: 787
Joined: Tue Mar 13, 2018 11:41 am
Location: Seattle
Contact:

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

Post by Ben Mathew » Sun Jan 13, 2019 6:40 pm

petulant wrote:
Sun Jan 13, 2019 5:30 pm
Ben Mathew wrote:
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.
There are good reasons to go with a 30-year mortgage,
I interpreted the required breakeven return of 6.6% nominal as high, and therefore a reason to go with the 15 year mortgage if possible.

But you're right that this is not directly related to OP's original point--taking out a 30 year mortgage and paying it off in 15 precludes investing the difference and this calculation does not apply. That's an even more expensive proposition.

User avatar
fortfun
Posts: 2458
Joined: Tue Apr 19, 2016 7:31 pm

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

Post by fortfun » Sun Jan 13, 2019 6:51 pm

Willthrill should talk about the cost of using a brick and mortar bank to finance one's mortgage. Going with an online provider will likely save another 1% over the brick and mortar bank. Just make sure you are getting a reputable company (Ally, Provident, etc.) and aren't paying any closing costs.

keystone
Posts: 543
Joined: Tue Aug 28, 2012 12:34 pm

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

Post by keystone » Sun Jan 13, 2019 6:53 pm

willthrill81 wrote:
Sun Jan 13, 2019 4:39 pm
I provided the source of the rates.
I'm not sure what you're looking at but according to Bank Rate the national average for a 30 year is 4.43% and 3.75% for a 15 year fixed ( as of January 13, 2019). The average for a 30 year has not been over 5% at any point in the last 4 months.

When I was shopping for mortgages 5 years ago there was about a 62.5 bp difference between 30 yr and 15 yr and that seems to be holding up now.

KlangFool
Posts: 14153
Joined: Sat Oct 11, 2008 12:35 pm

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

Post by KlangFool » Sun Jan 13, 2019 7:04 pm

danielc wrote:
Sun Jan 13, 2019 6:36 pm
KlangFool wrote:
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
Can you explain? With the numbers you posted, I would have taken a really serious look at the 15 years.
danielc,

Could you or could you not invest the savings from 30 years and earn more than 5% nominal? If the answer is yes, why don't you take 30 years?

A) The mortgage payment for 15 years = X

B) The mortgage payment for 30 years = Y

C) The difference is (X - Y).

D) If you can invest (X-Y) and earn more than 5%, you make money. In 15 years, you can pay off the 30 years mortgage with your investment of the difference.

KlangFool

User avatar
Topic Author
willthrill81
Posts: 13959
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

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

Post by willthrill81 » Sun Jan 13, 2019 7:42 pm

keystone wrote:
Sun Jan 13, 2019 6:53 pm
willthrill81 wrote:
Sun Jan 13, 2019 4:39 pm
I provided the source of the rates.
I'm not sure what you're looking at but according to Bank Rate the national average for a 30 year is 4.43% and 3.75% for a 15 year fixed ( as of January 13, 2019). The average for a 30 year has not been over 5% at any point in the last 4 months.

When I was shopping for mortgages 5 years ago there was about a 62.5 bp difference between 30 yr and 15 yr and that seems to be holding up now.
I see now that the 30 year rate I was looking at was as of 1/9/2018. They show the rates as of 1/2/2019 being 4.63%.
“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

User avatar
Topic Author
willthrill81
Posts: 13959
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

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

Post by willthrill81 » Sun Jan 13, 2019 7:44 pm

KlangFool wrote:
Sun Jan 13, 2019 7:04 pm
danielc wrote:
Sun Jan 13, 2019 6:36 pm
KlangFool wrote:
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
Can you explain? With the numbers you posted, I would have taken a really serious look at the 15 years.
danielc,

Could you or could you not invest the savings from 30 years and earn more than 5% nominal? If the answer is yes, why don't you take 30 years?

A) The mortgage payment for 15 years = X

B) The mortgage payment for 30 years = Y

C) The difference is (X - Y).

D) If you can invest (X-Y) and earn more than 5%, you make money. In 15 years, you can pay off the 30 years mortgage with your investment of the difference.

KlangFool
As noted above, the difference in rates today results in a breakeven point around 5.5% after tax. Earning a guaranteed 5.5% after tax these days isn't easy.
“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

KlangFool
Posts: 14153
Joined: Sat Oct 11, 2008 12:35 pm

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

Post by KlangFool » Sun Jan 13, 2019 7:50 pm

willthrill81 wrote:
Sun Jan 13, 2019 7:44 pm
KlangFool wrote:
Sun Jan 13, 2019 7:04 pm
danielc wrote:
Sun Jan 13, 2019 6:36 pm
KlangFool wrote:
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
Can you explain? With the numbers you posted, I would have taken a really serious look at the 15 years.
danielc,

Could you or could you not invest the savings from 30 years and earn more than 5% nominal? If the answer is yes, why don't you take 30 years?

A) The mortgage payment for 15 years = X

B) The mortgage payment for 30 years = Y

C) The difference is (X - Y).

D) If you can invest (X-Y) and earn more than 5%, you make money. In 15 years, you can pay off the 30 years mortgage with your investment of the difference.

KlangFool
As noted above, the difference in rates today results in a breakeven point around 5.5% after tax. Earning a guaranteed 5.5% after tax these days isn't easy.
willthrill81,

My portfolio earned 7% nominal per year. No, it is not risk-free. But, it is good enough for me.

KlangFool

User avatar
Topic Author
willthrill81
Posts: 13959
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

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

Post by willthrill81 » Mon Jan 14, 2019 12:23 pm

KlangFool wrote:
Sun Jan 13, 2019 7:50 pm
willthrill81 wrote:
Sun Jan 13, 2019 7:44 pm
KlangFool wrote:
Sun Jan 13, 2019 7:04 pm
danielc wrote:
Sun Jan 13, 2019 6:36 pm
KlangFool wrote:
Thu Jan 10, 2019 1:40 pm


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
Can you explain? With the numbers you posted, I would have taken a really serious look at the 15 years.
danielc,

Could you or could you not invest the savings from 30 years and earn more than 5% nominal? If the answer is yes, why don't you take 30 years?

A) The mortgage payment for 15 years = X

B) The mortgage payment for 30 years = Y

C) The difference is (X - Y).

D) If you can invest (X-Y) and earn more than 5%, you make money. In 15 years, you can pay off the 30 years mortgage with your investment of the difference.

KlangFool
As noted above, the difference in rates today results in a breakeven point around 5.5% after tax. Earning a guaranteed 5.5% after tax these days isn't easy.
willthrill81,

My portfolio earned 7% nominal per year. No, it is not risk-free. But, it is good enough for me.

KlangFool
Of course, taxes likely must be paid on that 7% as well.

It's certainly possible to beat a 5.5% after-tax return, but as you note, it's not risk-free. That's what we call it personal finance.

I find it interesting that you place so much focus on a high savings rate and not allocating more than 70% of your portfolio to stocks, but then you would pass up a guaranteed, after-tax 5.5% nominal return.
“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

KlangFool
Posts: 14153
Joined: Sat Oct 11, 2008 12:35 pm

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

Post by KlangFool » Mon Jan 14, 2019 12:34 pm

willthrill81 wrote:
Mon Jan 14, 2019 12:23 pm
KlangFool wrote:
Sun Jan 13, 2019 7:50 pm
willthrill81 wrote:
Sun Jan 13, 2019 7:44 pm
KlangFool wrote:
Sun Jan 13, 2019 7:04 pm
danielc wrote:
Sun Jan 13, 2019 6:36 pm


Can you explain? With the numbers you posted, I would have taken a really serious look at the 15 years.
danielc,

Could you or could you not invest the savings from 30 years and earn more than 5% nominal? If the answer is yes, why don't you take 30 years?

A) The mortgage payment for 15 years = X

B) The mortgage payment for 30 years = Y

C) The difference is (X - Y).

D) If you can invest (X-Y) and earn more than 5%, you make money. In 15 years, you can pay off the 30 years mortgage with your investment of the difference.

KlangFool
As noted above, the difference in rates today results in a breakeven point around 5.5% after tax. Earning a guaranteed 5.5% after tax these days isn't easy.
willthrill81,

My portfolio earned 7% nominal per year. No, it is not risk-free. But, it is good enough for me.

KlangFool
Of course, taxes likely must be paid on that 7% as well.

It's certainly possible to beat a 5.5% after-tax return, but as you note, it's not risk-free. That's what we call it personal finance.

I find it interesting that you place so much focus on a high savings rate and not allocating more than 70% of your portfolio to stocks, but then you would pass up a guaranteed, after-tax 5.5% nominal return.
willthrill81,

I considered housing as an expense. I considered the whole PITI as an expense. I am spending 20% to 30% less than market rent with my 30 years fixed rate mortgage PITI. So, why would I want to increase my housing expense with 15 years mortgage?

I made my money from imputed rent. I made 20% to 30% per year. Why would I waste it on 5.5% nominal return?

KlangFool

boglewill34
Posts: 161
Joined: Thu Nov 16, 2017 12:52 pm

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

Post by boglewill34 » Mon Jan 14, 2019 1:51 pm

I wonder if anyone has addressed this choice (among other mortgage choices) vis-a-vis how the various options will touch the FAFSA. If I'm attempting to be light in a taxable account for FAFSA, having additional home equity will obviously trump additional investments outside of pre- or non-taxed spaces. Thoughts, I'm still running the variety of scenarios out?

bgf
Posts: 1101
Joined: Fri Nov 10, 2017 9:35 am

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

Post by bgf » Mon Jan 14, 2019 1:59 pm

KlangFool wrote:
Mon Jan 14, 2019 12:34 pm
willthrill81 wrote:
Mon Jan 14, 2019 12:23 pm
KlangFool wrote:
Sun Jan 13, 2019 7:50 pm
willthrill81 wrote:
Sun Jan 13, 2019 7:44 pm
KlangFool wrote:
Sun Jan 13, 2019 7:04 pm


danielc,

Could you or could you not invest the savings from 30 years and earn more than 5% nominal? If the answer is yes, why don't you take 30 years?

A) The mortgage payment for 15 years = X

B) The mortgage payment for 30 years = Y

C) The difference is (X - Y).

D) If you can invest (X-Y) and earn more than 5%, you make money. In 15 years, you can pay off the 30 years mortgage with your investment of the difference.

KlangFool
As noted above, the difference in rates today results in a breakeven point around 5.5% after tax. Earning a guaranteed 5.5% after tax these days isn't easy.
willthrill81,

My portfolio earned 7% nominal per year. No, it is not risk-free. But, it is good enough for me.

KlangFool
Of course, taxes likely must be paid on that 7% as well.

It's certainly possible to beat a 5.5% after-tax return, but as you note, it's not risk-free. That's what we call it personal finance.

I find it interesting that you place so much focus on a high savings rate and not allocating more than 70% of your portfolio to stocks, but then you would pass up a guaranteed, after-tax 5.5% nominal return.
willthrill81,

I considered housing as an expense. I considered the whole PITI as an expense. I am spending 20% to 30% less than market rent with my 30 years fixed rate mortgage PITI. So, why would I want to increase my housing expense with 15 years mortgage?

I made my money from imputed rent. I made 20% to 30% per year. Why would I waste it on 5.5% nominal return?

KlangFool
your principal payment shouldn't be counted as an expense. interest, taxes, and insurance are actual expenses and should be compared to rent.

principal payments add to your net worth.

rent payments, like interest, taxes, and insurance, decrease your net worth.

you just don't like having your money tied up in your residence when it can be invested in the stock market. great, then never buy a house at all. just rent and keep as much of your net worth as possible in your investments.
“TE OCCIDERE POSSUNT SED TE EDERE NON POSSUNT NEFAS EST"

KlangFool
Posts: 14153
Joined: Sat Oct 11, 2008 12:35 pm

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

Post by KlangFool » Mon Jan 14, 2019 2:46 pm

bgf wrote:
Mon Jan 14, 2019 1:59 pm
KlangFool wrote:
Mon Jan 14, 2019 12:34 pm
willthrill81 wrote:
Mon Jan 14, 2019 12:23 pm
KlangFool wrote:
Sun Jan 13, 2019 7:50 pm
willthrill81 wrote:
Sun Jan 13, 2019 7:44 pm


As noted above, the difference in rates today results in a breakeven point around 5.5% after tax. Earning a guaranteed 5.5% after tax these days isn't easy.
willthrill81,

My portfolio earned 7% nominal per year. No, it is not risk-free. But, it is good enough for me.

KlangFool
Of course, taxes likely must be paid on that 7% as well.

It's certainly possible to beat a 5.5% after-tax return, but as you note, it's not risk-free. That's what we call it personal finance.

I find it interesting that you place so much focus on a high savings rate and not allocating more than 70% of your portfolio to stocks, but then you would pass up a guaranteed, after-tax 5.5% nominal return.
willthrill81,

I considered housing as an expense. I considered the whole PITI as an expense. I am spending 20% to 30% less than market rent with my 30 years fixed rate mortgage PITI. So, why would I want to increase my housing expense with 15 years mortgage?

I made my money from imputed rent. I made 20% to 30% per year. Why would I waste it on 5.5% nominal return?

KlangFool
your principal payment shouldn't be counted as an expense. interest, taxes, and insurance are actual expenses and should be compared to rent.

principal payments add to your net worth.

rent payments, like interest, taxes, and insurance, decrease your net worth.

you just don't like having your money tied up in your residence when it can be invested in the stock market. great, then never buy a house at all. just rent and keep as much of your net worth as possible in your investments.
bgf,

<<your principal payment shouldn't be counted as an expense. interest, taxes, and insurance are actual expenses and should be compared to rent. >>

Your opinion. It is not mine.

<<you just don't like having your money tied up in your residence when it can be invested in the stock market. great, then never buy a house at all. just rent and keep as much of your net worth as possible in your investments.>>

Why should I do that when I can lower my housing expense by buying? This is after considering the whole PITI as housing expense. I made money by buying. I improved my cash flow by buying.

KlangFool

delamer
Posts: 9324
Joined: Tue Feb 08, 2011 6:13 pm

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

Post by delamer » Mon Jan 14, 2019 6:15 pm

boglewill34 wrote:
Mon Jan 14, 2019 1:51 pm
I wonder if anyone has addressed this choice (among other mortgage choices) vis-a-vis how the various options will touch the FAFSA. If I'm attempting to be light in a taxable account for FAFSA, having additional home equity will obviously trump additional investments outside of pre- or non-taxed spaces. Thoughts, I'm still running the variety of scenarios out?
Are you expecting to qualify for non-merit scholarships/grants or just student loans?

If you are only qualifying for loans, then why worry about the impact on FAFSA of your choice?

inbox788
Posts: 6660
Joined: Thu Mar 15, 2012 5:24 pm

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

Post by inbox788 » Tue Jan 15, 2019 2:06 am

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.
Simple math, but 1% difference between rates on a $100k mortgage is $1000 just the first year and similar amounts the next few years. That's a high price to prepay for the possibility of a loan 15 years from now (years 16-30) that you don't intend to borrow (if you succeed in paying off the 30 year loan in 15 years). If it's not a big strain on your cash flow, even a smaller difference in interest is worth saving lots of interest over the long run by choosing the 15 year mortgage.

boglewill34
Posts: 161
Joined: Thu Nov 16, 2017 12:52 pm

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

Post by boglewill34 » Tue Jan 15, 2019 10:01 am

delamer wrote:
Mon Jan 14, 2019 6:15 pm
boglewill34 wrote:
Mon Jan 14, 2019 1:51 pm
I wonder if anyone has addressed this choice (among other mortgage choices) vis-a-vis how the various options will touch the FAFSA. If I'm attempting to be light in a taxable account for FAFSA, having additional home equity will obviously trump additional investments outside of pre- or non-taxed spaces. Thoughts, I'm still running the variety of scenarios out?
Are you expecting to qualify for non-merit scholarships/grants or just student loans?

If you are only qualifying for loans, then why worry about the impact on FAFSA of your choice?
I don't know yet, my kids are 6 (twins) and 8 years out still. But this year I'll probably be looking at refinancing along with other strategies. We'd EITHER be able to come close to paying off the house, OR maxing out both of our retirement accounts (457 and/or 403b) to reduce our AGI to a level of around $66k in today's dollars, but not both. The other choice won't likely be to fund taxable accounts much at this point, so the choice remains pertinent at the current time.

I'm frankly not entirely sure how having 2-3 students going to college concurrently operates with the EFC given that salary level. (Note, I ran a calculator just now and the EFC is quite low at this level, around $2300).

Edit add: we would also definitely qualify for the NYS Excelsior scholarship at that AGI level. It provides tuition free entry to SUNY and NYS community colleges with terminal degrees.

GAAP
Posts: 955
Joined: Fri Apr 08, 2016 12:41 pm

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

Post by GAAP » Tue Jan 15, 2019 2:36 pm

willthrill81 wrote:
Thu Jan 10, 2019 1:01 pm
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.
I would say you have those backwards -- if you don't have the emergency fund, you shouldn't be buying a house.

Another advantage to a 15-year loan is that you're less likely to buy too much house...
“Adapt what is useful, reject what is useless, and add what is specifically your own.” ― Bruce Lee

User avatar
Topic Author
willthrill81
Posts: 13959
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

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

Post by willthrill81 » Tue Jan 15, 2019 9:33 pm

GAAP wrote:
Tue Jan 15, 2019 2:36 pm
willthrill81 wrote:
Thu Jan 10, 2019 1:01 pm
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.
I would say you have those backwards -- if you don't have the emergency fund, you shouldn't be buying a house.

Another advantage to a 15-year loan is that you're less likely to buy too much house...
Yes, I misspoke. Buyers definitely need adequate emergency funds before taking out any mortgage.
“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

Texanbybirth
Posts: 1232
Joined: Tue Apr 14, 2015 12:07 pm

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

Post by Texanbybirth » Wed Jan 16, 2019 12:06 pm

Wow, I must say that this thread has been very informative. I particularly enjoyed seeing the math worked out on the implied return on the excess emergency fund required when one has a 15-year versus a 30-year mortgage.

It has me considering refinancing our 30-year note (4.125%, 26y left exactly) to a 15-year note (3.50% seems to be today's best rate), but I'd have to be comfortable with our emergency fund situation first.

:beer
Old Tom Bombadil is a merry fellow, | Bright blue his jacket is, and his boots are yellow. | None has ever caught him yet, for Tom, he is the master: | His songs are stronger songs, and his feet are faster.

User avatar
Ben Mathew
Posts: 787
Joined: Tue Mar 13, 2018 11:41 am
Location: Seattle
Contact:

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

Post by Ben Mathew » Fri Jan 18, 2019 11:07 am

Texanbybirth wrote:
Wed Jan 16, 2019 12:06 pm
Wow, I must say that this thread has been very informative. I particularly enjoyed seeing the math worked out on the implied return on the excess emergency fund required when one has a 15-year versus a 30-year mortgage.

It has me considering refinancing our 30-year note (4.125%, 26y left exactly) to a 15-year note (3.50% seems to be today's best rate), but I'd have to be comfortable with our emergency fund situation first.

:beer
Good idea. We bought a fixer upper and needed money for the remodel. So we went with a 30 year. I'd like to to refinance to a 15 year or a 10 year ARM with lower interest. But we bought when interest rates were very low (30 year @3.5%), so I doubt I'll find a lower rate now. Missed opportunity!

User avatar
dgm
Posts: 214
Joined: Sun Mar 13, 2011 10:32 pm

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

Post by dgm » Fri Jan 18, 2019 11:25 am

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

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.
Another option if you are seriously considering paying off in 15 yrs (and its pretty easy to do so) is an ARM with an initial fixed period. Say a 10/1 ARM (30 yr). The interest rate is lower than a 15 yr fixed and if you are paying it aggressively by the time the rates reset you will have paid off the bulk of the debt and can rollover to a new ARM (and of course continue to keep the same payoff schedule). Even at a substantially higher interest rate, the debt will be smaller so your total interest payments may be lower overall.

Not something I'd recommend unless the mortgage debt is very manageable but it will probably end up cheaper.

User avatar
vineviz
Posts: 5391
Joined: Tue May 15, 2018 1:55 pm

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

Post by vineviz » Fri Jan 18, 2019 11:40 am

willthrill81 wrote:
Thu Jan 10, 2019 1:01 pm
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.
A couple weeks ago I did some research and contemplation on the liquidity premium that one should associate with a mortgage, and ballparked a figure somewhere near 50 bps. Assuming that number for a second, it means that someone who is genuinely in a position to payoff the mortgage in 15 years should definitely think twice about taking out a 30 year mortgage if the rate was more than 0.50% higher than the rate on a comparable 15 year mortgage.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

User avatar
Riley15
Posts: 198
Joined: Wed May 11, 2016 9:21 pm

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

Post by Riley15 » Thu May 02, 2019 12:57 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.

I just worked this out for myself using current numbers: 15 Year Mortgage at 3.5% vs 30 Year Mortgage at 4.0%, a 0.5% interest rate rate spread. You just have to look at amortization table and compare.

For $100,000:
30 Year at 4.0% results in a monthly payment of $477
15 Year at 3.5% results in a monthly payment of $715

30 Year results in a lower payment by $238 per month.

If you ammortize the 30 year at the 15 year term (Paying off a 30 year "like" a 15 year mortgage with higher interest) your monthly payment is $740, so you have to pay $25 extra each month.

So you're paying $25 each month to have the "option" to pay $238 less each month. That's about a 10.5% liquidity cost.

At a 0.25% spread of Interest rate between the 15 Year vs 30 Year: you're paying $12 extra each month to have the "option" to pay $251 less each month. That's about a 4.9% liquidity cost.

At a 1.0% spread of interest rate between the 15 Year vs 30 Year: you're paying $50 extra each month to have the "option" to pay $208 less each month. That's about a 24% liquidity cost.

At 0.25% interest rate spread the 30 year mortgage may make sense, anything more than that the 15 Year Mortgage can't be beat! (except of course by the 10 year :P )

Miguelito
Posts: 283
Joined: Thu Feb 27, 2014 1:21 pm

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

Post by Miguelito » Thu May 02, 2019 1:31 pm

When we bought our current home (2012), given that the old one had not yet sold, we had to take on a fixed 4.25% 30-year loan on the new house. A few months later, a couple of months after the old house sold, we saw that we could get a 15-year loan at fixed 2.99%.

Despite paying $4k to refinance, we did it. As it turns out, as of 2018 we are not even deducting the interest, so in retrospect that decision was a no-brainer. The ROI on that $4k refinance cost was pretty quick given the 1.25% spread in interest rates and our ability to pay the higher payment with little risk.
Last edited by Miguelito on Thu May 02, 2019 5:04 pm, edited 1 time in total.

User avatar
Topic Author
willthrill81
Posts: 13959
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

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

Post by willthrill81 » Thu May 02, 2019 2:11 pm

Riley15 wrote:
Thu May 02, 2019 12:57 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.

I just worked this out for myself using current numbers: 15 Year Mortgage at 3.5% vs 30 Year Mortgage at 4.0%, a 0.5% interest rate rate spread. You just have to look at amortization table and compare.

For $100,000:
30 Year at 4.0% results in a monthly payment of $477
15 Year at 3.5% results in a monthly payment of $715

30 Year results in a lower payment by $238 per month.

If you ammortize the 30 year at the 15 year term (Paying off a 30 year "like" a 15 year mortgage with higher interest) your monthly payment is $740, so you have to pay $25 extra each month.

So you're paying $25 each month to have the "option" to pay $238 less each month. That's about a 10.5% liquidity cost.

At a 0.25% spread of Interest rate between the 15 Year vs 30 Year: you're paying $12 extra each month to have the "option" to pay $251 less each month. That's about a 4.9% liquidity cost.

At a 1.0% spread of interest rate between the 15 Year vs 30 Year: you're paying $50 extra each month to have the "option" to pay $208 less each month. That's about a 24% liquidity cost.

At 0.25% interest rate spread the 30 year mortgage may make sense, anything more than that the 15 Year Mortgage can't be beat! (except of course by the 10 year :P )
Thanks for the update. Yes, the cost of the optionality of the 30 year mortgage is still pretty steep relative to the 15 year.
“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

User avatar
9-5 Suited
Posts: 418
Joined: Thu Jun 23, 2016 12:14 pm

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

Post by 9-5 Suited » Thu May 02, 2019 2:42 pm

This is a great thread. In retrospect I wish I would have considered this in more detail at the time we made our decision. We had options of 20 year @ 2.75% or 30 year at 3.50% and defaulted to the "flexibility" heuristic. In reality we're going to pay off our mortgage significantly faster (7 years total) so the math isn't entirely relevant, but if we actually paid the 30-year over 20 years the "flexibility" would cost us $32,000 in nominal terms.

Wayercolor
Posts: 6
Joined: Sat Feb 09, 2019 6:00 pm

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

Post by Wayercolor » Thu May 02, 2019 3:01 pm

We always went with a 30 year for flexibility because our income can be a bit erratic but never needed it, First house paid off in 12 years, Vacation home condo sold after 6 years before payoff, but went with 30 years simple because we had a kid starting college that year. Second vacation home paid off in 11 years. Current home 7/1 arm 30 year, but we’re just one year in and will pay off soon. I don’t like ARMS, but it was a construction to perm and we knew we could pay it off at any time.

Admiral
Posts: 2476
Joined: Mon Oct 27, 2014 12:35 pm

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

Post by Admiral » Fri May 03, 2019 9:51 am

It would be interesting to know (even anecdotally) how many of the "get a 30 and pay it off in 15" crowd actually do this. My guess is not many. Especially since interest rates were on a pretty much downward trajectory from 2000 to 2017. I've seen my loan rates go like this (refis or new purchases):

8.25%
6.00%
5.25%
4.00%
2.25%

User avatar
Topic Author
willthrill81
Posts: 13959
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

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

Post by willthrill81 » Sun Jun 16, 2019 10:23 pm

Considering that interest rates have fallen quite a bit since earlier in the year, I thought that I would update the numbers.

According to BankRate.com, the average 30 year mortgage rate is currently 3.92%, and the average 15 year mortgage rate is 3.23%. At these rates, the difference in total interest paid between paying off a 30 year mortgage in 15 years vs. paying off the 15 year mortgage in 15 years is $6,118.20 per $100k borrowed. That's significantly less than it was earlier in the year, but it still seems like a hefty price to pay for flexibility that can largely be 'bought' with a higher EF.
“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

User avatar
Devil's Advocate
Posts: 293
Joined: Thu Feb 16, 2012 5:18 pm

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

Post by Devil's Advocate » Mon Jun 17, 2019 1:46 am

Yes,

But isn't there a cost associated with keeping your money out of the market and in an EF?

Wouldn't that make the cost of flexibility lower??

DA

User avatar
snackdog
Posts: 804
Joined: Wed Nov 12, 2014 4:57 am

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

Post by snackdog » Mon Jul 22, 2019 4:11 pm

willthrill81 wrote:
Mon Jan 14, 2019 12:23 pm
KlangFool wrote:
Sun Jan 13, 2019 7:50 pm
willthrill81 wrote:
Sun Jan 13, 2019 7:44 pm
KlangFool wrote:
Sun Jan 13, 2019 7:04 pm
danielc wrote:
Sun Jan 13, 2019 6:36 pm


Can you explain? With the numbers you posted, I would have taken a really serious look at the 15 years.
danielc,

Could you or could you not invest the savings from 30 years and earn more than 5% nominal? If the answer is yes, why don't you take 30 years?

A) The mortgage payment for 15 years = X

B) The mortgage payment for 30 years = Y

C) The difference is (X - Y).

D) If you can invest (X-Y) and earn more than 5%, you make money. In 15 years, you can pay off the 30 years mortgage with your investment of the difference.

KlangFool
As noted above, the difference in rates today results in a breakeven point around 5.5% after tax. Earning a guaranteed 5.5% after tax these days isn't easy.
willthrill81,

My portfolio earned 7% nominal per year. No, it is not risk-free. But, it is good enough for me.

KlangFool
Of course, taxes likely must be paid on that 7% as well.

It's certainly possible to beat a 5.5% after-tax return, but as you note, it's not risk-free. That's what we call it personal finance.

I find it interesting that you place so much focus on a high savings rate and not allocating more than 70% of your portfolio to stocks, but then you would pass up a guaranteed, after-tax 5.5% nominal return.
5.5% risk-free sounds good looking forward, but actual market performance the last decade or so has been far better so the 30-year choice would have led to the best financial outcome. In fact, over 30 years I don't think the US market has ever returned less than 5.5% CAGR.

User avatar
Topic Author
willthrill81
Posts: 13959
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

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

Post by willthrill81 » Mon Jul 22, 2019 5:34 pm

snackdog wrote:
Mon Jul 22, 2019 4:11 pm
willthrill81 wrote:
Mon Jan 14, 2019 12:23 pm
KlangFool wrote:
Sun Jan 13, 2019 7:50 pm
willthrill81 wrote:
Sun Jan 13, 2019 7:44 pm
KlangFool wrote:
Sun Jan 13, 2019 7:04 pm


danielc,

Could you or could you not invest the savings from 30 years and earn more than 5% nominal? If the answer is yes, why don't you take 30 years?

A) The mortgage payment for 15 years = X

B) The mortgage payment for 30 years = Y

C) The difference is (X - Y).

D) If you can invest (X-Y) and earn more than 5%, you make money. In 15 years, you can pay off the 30 years mortgage with your investment of the difference.

KlangFool
As noted above, the difference in rates today results in a breakeven point around 5.5% after tax. Earning a guaranteed 5.5% after tax these days isn't easy.
willthrill81,

My portfolio earned 7% nominal per year. No, it is not risk-free. But, it is good enough for me.

KlangFool
Of course, taxes likely must be paid on that 7% as well.

It's certainly possible to beat a 5.5% after-tax return, but as you note, it's not risk-free. That's what we call it personal finance.

I find it interesting that you place so much focus on a high savings rate and not allocating more than 70% of your portfolio to stocks, but then you would pass up a guaranteed, after-tax 5.5% nominal return.
5.5% risk-free sounds good looking forward, but actual market performance the last decade or so has been far better so the 30-year choice would have led to the best financial outcome. In fact, over 30 years I don't think the US market has ever returned less than 5.5% CAGR.
The difference between a 30 year and a 15 year mortgage is 15 years, not 30. Since 2000, U.S. stocks have returned 5.94%, but that's pre-tax and came with a lot of volatility. Yes, stocks have done well since 2010, but stocks posted a real loss from 2000-2009, so don't let recency bias flavor your analysis. 30 year mortgage rates in the year 2000 were ~8%, so paying down that mortgage early would have been significantly better than buying stocks. Whether that's the case going forward, I don't know.

But all of that aside, the purpose of this thread, as stated in the OP, was not to debate the merits of a 30 year vs. a 15 year mortgage but to highlight the cost of taking out a 30 year mortgage that you plan to pay off in 15 years.
“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

WhiteMaxima
Posts: 2031
Joined: Thu May 19, 2016 5:04 pm

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

Post by WhiteMaxima » Mon Jul 22, 2019 5:37 pm

Paying off mortgage 30 years, pay less interest (10/1/ or 7/1 ARM), refinance.

SovereignInvestor
Posts: 433
Joined: Mon Aug 20, 2018 4:41 pm

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

Post by SovereignInvestor » Tue Jul 23, 2019 7:30 am

willthrill81 wrote:
Mon Jul 22, 2019 5:34 pm
snackdog wrote:
Mon Jul 22, 2019 4:11 pm
willthrill81 wrote:
Mon Jan 14, 2019 12:23 pm
KlangFool wrote:
Sun Jan 13, 2019 7:50 pm
willthrill81 wrote:
Sun Jan 13, 2019 7:44 pm


As noted above, the difference in rates today results in a breakeven point around 5.5% after tax. Earning a guaranteed 5.5% after tax these days isn't easy.
willthrill81,

My portfolio earned 7% nominal per year. No, it is not risk-free. But, it is good enough for me.

KlangFool
Of course, taxes likely must be paid on that 7% as well.

It's certainly possible to beat a 5.5% after-tax return, but as you note, it's not risk-free. That's what we call it personal finance.

I find it interesting that you place so much focus on a high savings rate and not allocating more than 70% of your portfolio to stocks, but then you would pass up a guaranteed, after-tax 5.5% nominal return.
5.5% risk-free sounds good looking forward, but actual market performance the last decade or so has been far better so the 30-year choice would have led to the best financial outcome. In fact, over 30 years I don't think the US market has ever returned less than 5.5% CAGR.
The difference between a 30 year and a 15 year mortgage is 15 years, not 30. Since 2000, U.S. stocks have returned 5.94%, but that's pre-tax and came with a lot of volatility. Yes, stocks have done well since 2010, but stocks posted a real loss from 2000-2009, so don't let recency bias flavor your analysis. 30 year mortgage rates in the year 2000 were ~8%, so paying down that mortgage early would have been significantly better than buying stocks. Whether that's the case going forward, I don't know.

But all of that aside, the purpose of this thread, as stated in the OP, was not to debate the merits of a 30 year vs. a 15 year mortgage but to highlight the cost of taking out a 30 year mortgage that you plan to pay off in 15 years.
A couple points

1) If someone takes 30Yr there's no stopping them from refinancing in 15 years to a 15 year at a lower rate. That is speculative the rate would be lower but of rates were flat it usually is lower. The optional it benefit is something that can reduce interest for person with initally 30Y mortgage

2) The return from 2000 to present isn't meaningful. When you mention taking lower payments over the 15 year period and investing them then it's not 2000 to present that matters but time weighted returns. So some money was invested in 2000 and got mediocre returns but some went in market in 2002-03 with solid returns and 2008-11 with tremendous returns.

Definitionally taking longer mortgage to invest lower payment has built in DCA element which smoothes out returns and makes it more likely the long term average returns are nearly reached.

3) If one takes a 30Y mortgage he has more flexibility if something bad happens. There is a cost but the substantially reduced risk in form of lower payment may also allow the investor to take more equity risk in their AA for portfolio if they choose to be neutral overall in terms of risk. Ie if the 30Y mortgage means a 10K lower annual required payment for years 1-15, then during those years theoretically while being risk neutral the person can have increased portfolio equity exposure such that a probable theoretical max crash over say a 2 year horizon would wipe away say 20K ( 2 years of mortgage savings) additional wealth so..if they use 50% crash as a standard then they can have 40K more wealth in equities in theory. Most will not consider this element but it is important to compare risk neutrality.

It's hard to quantify precisely but if the average annual higher interest expense for 30Y versus 15Y is say 1K a year but they invest or can take 40K more equity risk initially and historical equity risk premium is about 5%, then on average the benefit of being able to take more equity risk to offset lower mortgage payment risk would be 2K/Year (5% of 40K) in this example so the 2K additional equity risk benefit would more than cancel the extra 1K of interest expense


These are fake numbers but this sort of analysis can be performed. I believe the equity risk premium greatly exceeds the extra interest cost for keep a 30Y term so I prefer longest term possible.

Retired2013
Posts: 202
Joined: Sat Dec 12, 2015 2:53 pm

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

Post by Retired2013 » Tue Jul 23, 2019 9:23 am

I once heard that most people only stay in their homes an average of 7 years. We built 26 years-ago and many homes in the neighborhood are now on their third owners (divorce, foreclosure, job relocation, down-sized or just time for a new home). Only a handful of original owners left. Then you have the refinances which closes the old loan sooner than original loan term.

On that assumption, I looked a rate buy-downs also. I see that the usual rate-buy-down seems to break-even around the 7 year mark (I found that interesting).

How many people really keep a mortgage for 30 years? Not many!

Personal history:
First Mortgage 1985 30 years @ 13.5%, refinanced after 1.5 yrs to 15 yrs @ 10.5%, paid in 5 yrs.
Had home built in 1993. Next mortgage 15 yrs @ 10.5% paid in 5 yrs.
Mortgage free since 1998.

stoptothink
Posts: 6524
Joined: Fri Dec 31, 2010 9:53 am

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

Post by stoptothink » Tue Jul 23, 2019 9:38 am

Retired2013 wrote:
Tue Jul 23, 2019 9:23 am
I once heard that most people only stay in their homes an average of 7 years. We built 26 years-ago and many homes in the neighborhood are now on their third owners (divorce, foreclosure, job relocation, down-sized or just time for a new home). Only a handful of original owners left. Then you have the refinances which closes the old loan sooner than original loan term.
We've lived in our home for 3.5yrs. In that time period only 2 of 7 of our closest neighbors have not moved. The home next door and the one directly across the street are on their 3rd owners since we moved in. With my peers, it's like they have a car-leasing mentality when it comes to homes. Do people not realize the transition costs involved in buying and selling homes?

We got a 15yr mortgage (because it could easily be afforded on one income) and are going to have it paid off <6yrs...of course the wife has been talking "upgrade" almost since we moved in.

Jablean
Posts: 297
Joined: Sat Jun 02, 2018 2:38 pm

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

Post by Jablean » Wed Jul 24, 2019 1:19 am

Always check different banks/credit unions for different years. Some will have a special on the 30 yr while another will have one on the 15yr. Credit Unions tend to give you partial % discounts if you also have money with them so an advertised 3.25 might actually cost you 3.15.

Having the 30yr made the difference for us of investing in 401k or Roths to diversify so that we weren't house poor but actually had investments that could take advantage of compound interest etc.

First house, lived in for 3, rented out for 2
2nd house, lived in for 5, rented out for 3
3rd house, went with a 30yr as still paying on credit card for 1st kid's birth, refinanced yr 4 to another 30 (7%to 5.25%), refinanced yr 13 down to a 15yr at 3% same monthly payment, paid off in year 20. I like the flexibility, used it often, usually paid about 20% more than the monthly pay and when it got down in high credit card territory paid it off in lump sums.

msk
Posts: 1390
Joined: Mon Aug 15, 2016 10:40 am

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

Post by msk » Wed Jul 24, 2019 3:34 am

I always hated loans, except those that made me money like in rental RE. For my home I read somewhere a half century back that one should budget 25% of income/expenditure for the home. My target has always been to save-and-invest 30+% of after tax income. But it is reasonable to treat paying off principal (not mortgage interest) in the home as saving-and-investing. Hence from my first mortgage my aim was to pay 25% of my income into the home mortgage. My first home was at a time of 8.5% mortgage rates (England) but I was still able to be fully paid off on my first home way before I was 40. I had some rental RE mortgages still active though. But those made me more :greedy Flexibility costs, and to have a fully paid off home gives you tremendous flexibility. Just use 25% of your income to pay off that sword of Damocles asap and be done.

Reamus294
Posts: 56
Joined: Wed Jul 24, 2019 8:54 am

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

Post by Reamus294 » Wed Jul 24, 2019 2:48 pm

We chose the 30 year over the 15 year about 10 years ago because of the peace of mind it gave us. While we intended on paying the 15 year amount, it would have been tight for us at that time. It will be paid in about 16-17 years. We didn't have a large emergency fund back then and didn't want to make any hasty decisions if one of us lost our jobs.

We could have bought a cheaper house to go with a 15 year mortgage, but we lucked out that our current house has appreciated more and we don't need to move anytime in the near future because we didn't buy what would have felt like a "starter home".

GrowthSeeker
Posts: 714
Joined: Tue May 15, 2018 10:14 pm

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

Post by GrowthSeeker » Thu Jul 25, 2019 7:10 pm

LiterallyIronic wrote:
Thu Jan 10, 2019 1:25 pm
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.
I was feeling a bit number crunchy, so I ran a mortgage scenario:
Loan: $150,000
Start: September 2017
Today is: July 2019
Rate: 3.875%
30 years
Std pmt (P+I): $705.36
Overpay plan: either this month's Interest minus Principal amount or $200 whichever is greater.
September 2017's extra payment: $263.39, close to your $265
Feb 2019's extra payment: $214.54, close to your $216

30 year mortgage paid off in 19 years 9 months (May 2037) which is 17 yrs and 10 mos from now.
---
If instead one made an extra payment of $394.80 right from the beginning, the 30 year loan would be paid off in 15 years.
Just because you're paranoid doesn't mean they're NOT out to get you.

User avatar
Topic Author
willthrill81
Posts: 13959
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

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

Post by willthrill81 » Thu Jul 25, 2019 9:41 pm

Reamus294 wrote:
Wed Jul 24, 2019 2:48 pm
We chose the 30 year over the 15 year about 10 years ago because of the peace of mind it gave us. While we intended on paying the 15 year amount, it would have been tight for us at that time. It will be paid in about 16-17 years. We didn't have a large emergency fund back then and didn't want to make any hasty decisions if one of us lost our jobs.

We could have bought a cheaper house to go with a 15 year mortgage, but we lucked out that our current house has appreciated more and we don't need to move anytime in the near future because we didn't buy what would have felt like a "starter home".
It sounds like you bought too much house for your income but got lucky with property appreciation and stable if not increasing income. I'm glad that it worked out for you, but I wouldn't recommend that path for anyone. Millions got into big trouble with such a strategy a decade ago.
“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

Reamus294
Posts: 56
Joined: Wed Jul 24, 2019 8:54 am

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

Post by Reamus294 » Fri Jul 26, 2019 8:51 am

willthrill81 wrote:
Thu Jul 25, 2019 9:41 pm
Reamus294 wrote:
Wed Jul 24, 2019 2:48 pm
We chose the 30 year over the 15 year about 10 years ago because of the peace of mind it gave us. While we intended on paying the 15 year amount, it would have been tight for us at that time. It will be paid in about 16-17 years. We didn't have a large emergency fund back then and didn't want to make any hasty decisions if one of us lost our jobs.

We could have bought a cheaper house to go with a 15 year mortgage, but we lucked out that our current house has appreciated more and we don't need to move anytime in the near future because we didn't buy what would have felt like a "starter home".
It sounds like you bought too much house for your income but got lucky with property appreciation and stable if not increasing income. I'm glad that it worked out for you, but I wouldn't recommend that path for anyone. Millions got into big trouble with such a strategy a decade ago.
I agree that you shouldn't buy a house with expected future income or expected future property appreciation. We bought right after the downturn, so we understood what could happen with taking on too much risk. Our mortgage/taxes/insurance was still under 25% of our take home, so we felt comfortable with our situation. I should have mentioned in the first post that the mortgage to take home pay percentage should be taken into account when trying to decide between the 30 and 15yr. The extra final cost of the 30 yr was worth it to us to stay under the 25% of take home.

We made plenty of other mistakes that I wouldn't recommend like only 5% down and having an 80/15 loan, but that's before I found the boglehead light and another story.

Post Reply