A 15-Year Mortgage - Not A Good Idea
by Benny L. Kass
Question: I have signed a contract to purchase my first home. Interest rates are currently low, and I am concerned that they may start rising in the near future. I have been researching available mortgages and have found a number of options -- from a fixed 30-year to a one-year adjustable. Because I plan to hold this house for a long period of time, I am not comfortable with an adjustable-rate mortgage. I fear that in the years to come, the interest rate (and thus my mortgage payments) will become prohibitive. I have been considering obtaining a 15-year mortgage. What are the advantages and disadvantages of the 15-year versus the 30-year mortgage? Answer: At the outset, I have to state that I do not favor the 15-year loan. While there are those who praise what they perceive to be the benefits of a 15-year mortgage, in my opinion, such a mortgage rarely makes sense for the average homeowner. Let's look at some examples. You want to compare a $250,000 loan to be amortized on a 30-year basis as compared to a 15-year basis. Most lenders will give you a slightly lower interest rate if you take a 15-year loan rather than the 30-year, so for comparison purposes, let us assume that the 30 year will carry an interest rate of 5.75 percent while the 15-year loan will be at 5.5 percent. To amortize the loan over 15 years, your monthly payment of principal and interest (P&I) will be $2,042.71. On a 30-year basis, the P&I is $1,458.92. The difference between the two rates is $583.78 per month, or $7005.36 per year. In other words, you will be savings over $7000 per year if you opt for the 30-year loan. Obviously, over the life of your mortgage -- if you keep the same house and the same mortgage -- the 15-year loan will save you a lot of mortgage interest payments. Since your principal balance on the loan will be reduced faster with a 15-year amortization, accordingly your interest payments will also be smaller. Because you are paying more to principal every month, your outstanding mortgage balance will be reduced more rapidly than with a 30-year loan, thereby reducing your mortgage balance and building up your equity. Equity is the difference between the market value of your house and the mortgage or mortgages which you owe. In good real estate market conditions, property values increase on a yearly basis as much as 10 to 15 percent. Indeed, in the last few years, we have seen appreciation as high as 20 percent per year in some parts of the country. Even in bad times, we all hope that property values will at least keep up with inflation, although obviously there will be dips and decreases in market values on a periodic basis. But assuming that we anticipate growth over the next decade, the equity in your house will grow regardless of the amount of your mortgage. This equity is "dead equity" and in my opinion, you might as well be taking that extra $7,000 per year and burying it in your back yard. In effect, that is my analogy for the 15-year mortgage. I would rather take the extra $7,000 a year and invest it somewhere. I could put it in a pension plan, I could invest it in the stock market, I could give it to my grandchildren, or I could spend it on a vacation with my family. After all, what will you do with your house 15 years from now when your mortgage is paid in full? I know of too many people who currently are house rich and cash poor. When you are in retirement, you may not want to keep that house, or if you do, you want to make sure that you also have some sort of nest egg to be able to enjoy your retirement years. If you have put all of your money into your house, and then you retire, you may not be in the financial position to tap into that equity at that later date. Or, you will have to obtain a reverse mortgage. Accordingly, in my opinion, you are better off with the 30-year loan. Take the extra $7,000 a year and invest it in a conservative, long-term investment for the next 15 years. Even without any computation for interest or appreciation, this will grow to over $105,000 in the next 15 years. That will be a good start toward your nest egg for that rainy day. There is one additional advantage that I see for the 30-year mortgage. Most mortgage lenders will not charge you any pre-payment penalty when you obtain a fixed mortgage loan. Thus, if you take a 30-year mortgage, and want to make additional extra monthly payments to principal, you have the right to do this. If you have the extra money -- and do not have any other investment opportunities immediately available -- you can make an extra monthly payment in the amount of $583.78, and in effect you now have a loan which can be paid off in 15 years. In fact, you can always make monthly payments which are higher than that which is required. Keep in mind, however, that every time you make such an extra payment, make sure that you write on your check and on the statement which you send back to the bank that you are making "extra principal payment." When you get your next monthly statement, make sure that the principal amount of your loan has been reduced by this extra payment. The major advantage, in my opinion, of the 30-year loan is that it gives you the right -- but not the obligation -- to make larger monthly payments. If a better investment comes your way -- or if you need additional money for emergency purposes -- you can resume making the regular (lower) monthly payment and use the extra cash elsewhere. Finally, from a tax point of view, the 30-year loan -- even though the mortgage payments are lower -- gives you more interest deductions than does the 15-year loan. For all these reasons, I see no reason why most homeowners should even consider a 15-year mortgage loan. However, the advice I give is obviously general. Some people who may not have to pay income tax may have other considerations. You are always advised to discuss your specific needs, plans and tax considerations with your own advisors. | 
