A True 15 vs 30 Year Mortgage Analysis

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Save on Interest or Save More Money

Typically, we’re shown how much money we’ll save in interest on a 15 vs 30-year mortgage option. Unfortunately, most people aren’t taught how much money they will lose by paying off a mortgage early.

Purchasing a home is a huge financial decision that will have a significant impact on your future. Some consider their home a part of their retirement planning so it’s important to understand the different strategies and costs associated with a purchase.

People have different beliefs and goals regarding retirement, so a cookie cutter approach is not in the best interest of most. Some plan to pay off a huge home during their working years then sell it, purchase a smaller home and use the remaining profit to help fund retirement. This could be a good strategy if the plan involves selling a huge home in an expensive state like California and purchasing a smaller home in a less expensive state like Tennessee. However, if you’re planning on staying in the same area, downsizing may not provide a significant enough profit to use as a nest egg. No matter what your plan is, it’s good to understand the potential accumulated value when comparing a 15 vs a 30-year mortgage.

In the following exercise, we will use interest rates that remain the same throughout the example, on a $200k mortgage, with zero money down and a budget of $1,381 per month for this strategy.

Banks offer lower interest rates on shorter term loans, so we’ll use:

3% on a 15-year term

4% on a 30-year term.

Assumed 30% tax bracket

6% Cost of Money / Rate of Return (Based on a middle of the road age and risk tolerance)

 

Have you ever wondered why banks offer lower interest rates on shorter term loans? I’ll explain why at the end of the exercise.

 

Person A – 15-year Mortgage

15-year mortgage with a 3% = $1,381 per month.

After 15 years the mortgage is paid off and you’ll have paid $48,609 in interest. Since the mortgage was paid off in year 15, we’ll use years 16-30 to invest the budgeted amount of $1,381 per month ($16,782 per year) towards savings. Using a 6% rate of return, at the end of year 30, you will have accumulated:

$408,873

 

Person B – 30-year Mortgage

30-year with a 4% = $954 per month.

After 30 years the mortgage is paid off and you’ll have paid $143,736 in interest ($95,127 more than the 15-year). At this point we have proven that you’ll pay more in interest on a 30-year mortgage than a 15-year mortgage, but we haven’t completed the full analysis. Since the 30-year mortgage payment is $427 less per month, we’ll invest the difference ($5,124 annually) for 30 years. Using a 6% rate of return, at the end of year 30, you will have accumulated:

$429,399

 

On a 30-year mortgage you paid $95,137 more in interest but your total accumulation at year 30 is $20,526 more. But WAIT, there’s more. The government is going to subsidize your mortgage. How much would you like them give you?

 

Mortgage Interest Deduction

15-year mortgage

Over a 15-year period you will have paid a total of $48,609 in interest that you can deduct from your taxes. If you use the money saved in taxes to continue your savings strategy, earning a 6% ROR, it will add another $27,131 to your total accumulated value at the end of 15 years. For years 16-30 you have no more tax deductions so that savings will grow to $66,582 by year 30 giving you a total accumulation of

$675,455

 

30-year mortgage

Over a 30-year period you will have paid a total of $143,746 in interest that you can deduct from your taxes. If you use the money saved in taxes to continue your savings strategy, earning a 6% ROR, it will add another $146,736 to your total accumulated value by year 30 giving you a total accumulation of

$776,135

 

Total accumulation after 30 years is $100k MORE with the 30-year mortgage.

$675,455 – 15-year mortgage

$776,135 – 30-year mortgage

 

Do you want to be Debt Free and broke or do you want to have More Money and access to it sooner? At the end of a 15-year mortgage you are debt free but have no access to other capital (broke). With a 30-year mortgage, your capital grows from the first month with immediate access. After 15 years, your savings account is large enough to pay off the mortgage, therefore nearly eliminating risk.

 

Think back to 2008 when both the housing and financial markets crashed. Did you hear how people lost their homes to the bank, having owed less than $10k on their mortgage, because they couldn’t make their payments on time? The bank owns your home until the very last payment is made. Would you rather have the cash equivalent saved in an account that you could access at any time while it continues to earn uninterrupted compounding interest?

 

Why do banks offer lower interest-rate on short term loans?

 

It’s due to the fact that they make more money off of other people’s money. When you put money in a bank, they pay you a fraction of a percent in interest. Then they use your money to loan out at 3% to 4% on a mortgage. Additionally, due to the bank’s capital reserve, they’re able to loan out multiple dollars for everyone single dollar that you put in.

Banks, government and celebrity financial entertainers (seen on TV and in church) use all forms of media toward fulfilling their agendas. Statements like “Debt is bad” or “Buy term life Insurance and invest the rest” clearly aren’t in everyone’s best interest. Take time to get a second opinion on any financial decisions or strategies you’re considering.

 

For more information on the areas Ringo Financial can help, click on the “Services” drop down menu at the top of the page.

 

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