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Is It Really Worth Trying to Retire a 30-Year Home Loan in 15?

real_estate_7When it comes to the great mortgage debate, I’ve already explained my position regarding 15- and 30-year loans: 30-year loans are better for a multitude of reasons. In fact, I think it’s a no-brainer.

I remember when I bought my first home in 1990, interest rates were in double-digit territory. Today, 30-year loans make more sense than ever with mortgage interest rates at or near all-time lows. In fact, as of January 2015, a homebuyer with excellent credit could still find a 30-year loan for rates as low as 3.375% and 15-year loans for an incredible 2.75%.

Enjoy it while you can, folks. Although it’s hard to believe, higher interest rates are inevitable.

More Flexibility Means Less Risk

One of the biggest advantages of the 30-year loan is its flexibility. After all, holders of 30-year loans can always make the extra payments required to pay them off in 15 years, should they choose to do so.

However, the poor guy with a 15-year note who suddenly gets laid off or runs into other unexpected financial difficulties, can’t reduce his payments in order to stretch that 15-year mortgage into a 30-year loan. Sure, he could try to refinance, but that can be difficult — especially for the unemployed.

Of course, the trade-off for having additional flexibility is higher interest payments.

Assuming a $200,000 loan, the impacts of those higher interest payments over time at today’s rates and can be seen in the following chart:

30-vs-15-interest-payments4

Obviously, folks with a 30-year mortgage are going to pay more interest, whether or not they make the extra payments required to retire their loan in roughly 15-years. Then again, how much more depends on how picky they are about getting the loan paid off in exactly 15 years.

In my example, a 30-year $200,000 mortgage at 3.375% results in a monthly payment of $884; and if you wanted to pay off that same 30-year loan inexactly 15 years, you could do so by increasing the monthly payments to $1424. (That’s $540 more than the minimum payment.)

In nominal terms, a homeowner will pay $118,309 in interest to the lender — that’s more than $70,000 compared to the 15-year loan at 2.750%! Alternatively, faithfully making monthly payments over the life of the loan equal to the 15-year mortgage at 2.75% ($1357) results in far-lower additional nominal interest costs of $14,330. However

When one considers the declining value of those dollars over time (as shown in the Present Value column), the analysis is quite different because the resulting financial impacts aren’t as pronounced. In fact, the 15-year mortgage is actually “just” $12,994 cheaper in today’s dollars than the 30-year loan. So those who desire the flexibility of a 30-year mortgage with lower monthly payments still pay a premium for that convenience — but it’s just $36 per month in today’s dollars. Not bad.

One last observation: For this example, paying off a 30-year mortgage early probably isn’t worth the effort. As the Present Value column indicates, even if the 30-year loan is retired in half the time, the real savings amount to little more than $3000.

So there you have it. Hopefully, this little example provides you with a bit more insight into just how much extra it currently costs to take on a 30-year loan over its 15-year cousin.

Yes, people who prefer the numerous advantages of a 30-year loan over a 15-year mortgage are always going to pay more interest.

But for those who are looking for the extra flexibility of a 30-year loan as a hedge against a sudden loss of income or the prospect of high inflation, the added premium is a relative bargain.

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