A 15-Year Mortgage or a 30-Year Mortgage: Which is Better?
There is no generic answer to the age-old question “Is it better to invest or pay off debt?” This can be looked at several ways, especially when the debt in question is a mortgage.
Is a 15-year or 30-year mortgage a better option?
The choice between a 15-year loan at a mortgage rate of 5 percent and a 30-year mortgage at 5.5 percent seems clear-cut on a $100,000 mortgage loan, for example.
The monthly payment on the 15-year mortgage will be about $800, while the interest paid over the life of the note is about $42,000.
Because the interest paid on home loans is deductible, in an average 25 percent tax bracket, this makes the actual interest cost closer to $32,000.
With the same assumptions on a 30-year mortgage loan, the monthly payment calculates to about $225 less, but the interest over the life of the note will cost about $46,000 more after tax.
But consider the flexibility of the 30-year mortgage.
If the homeowner was to invest the $225 per month into stocks that returned 6 percent after tax for 15 years, the balance would be more than $65,000. The balance due on the 30-year home loan after 15 years is about $70,000.
Within the next eight months, the homeowner actually will have more saved than the balance due on the mortgage. The key to this strategy is the homeowner actually must save each and every month.
If not, he or she may have been better off with the “forced savings” imposed by the 15-year mortgage - a popular choice, as well, for mortgage refinancing.
Investing involves risk, and you may incur a profit or a loss. Examples provided here and elsewhere are hypothetical and do not suggest or guarantee particular rates of return for any investment.
The examples do not include transaction costs and tax considerations that would reduce an investor’s return. So is paying extra better?
How about making 13 home mortgage payments every year, starting in the first year, but taking the longer 30-year mortgage?
The extra $570 reduces the after-tax interest cost about double that of the 15-year option (to $63,000) but gets the mortgage paid off about five years ahead of schedule.
Or, sending a flat amount of extra money along with each month’s mortgage payment may be a worthwhile strategy. An extra $100 per month would pay off the mortgage about eight years early.
Of course, investing the $100 per month could net the homeowner even more, as seen in our earlier example. Each of these options requires discipline.
If one does not have the discipline to actually send the mortgage lender the additional cash, then the forced savings of the 15-year loan might be the best bet.
Likewise, if you have the risk tolerance to invest the money, perhaps investing is the best alternative along with the 30-year mortgage.
It just goes to show that there is no one right answer to the question, but rather it depends on your personal situation and feelings.
SOURCE: Huntsville Times