How a 30-Year Fixed Mortgage Holds You Back Financially

by Kevin on March 11, 2012

When it comes to mortgages I have long said a 30-year fixed mortgage is better than a 15-year fixed mortgage. I have long believed that the few extra hundred dollars of flexibility you get every month by getting a 30 year mortgage over a 15 is critical. As long as you pay the 30 year like you would pay a 15 year (through added principal payments), the difference is negligible. You’re trading minimal interest (about 6-9 months of payments) for increased flexibility throughout the life of the loan.

But there’s a catch: you have to pay the 30-year mortgage like a 15-year mortgage. If you don’t, the math heavily favors going with a 15-year because you save so much money in interest.

Why We’re Stuck on 30-Year Mortgages

The 30-year fixed rate mortgage is a standard in the American mortgage industry. Some of its proponents think this is because it makes homes more affordable and offers a “good enough” balance between a lower payment and paying more interest.

But I’m a bit more cynical.

In my opinion 30 year mortgages are popular because they are more profitable than 15 year mortgages for banks. Add in the fact that we live in an immediate gratification society where everyone wants the bigger, better house now rather than waiting, that lower payment really helps out with buying the McMansion.

There’s only two catches, right? Can’t we just ignore those? Wouldn’t it be convenient?

No. There is a huge difference between a 15 and 30 year mortgage. With the 30, you end up paying a mortgage payment for an extra 15 years! Even taking interest out of the equation, another 15 years of payment (180 payments) is still a ton of money.

The second catch is tied right into that: you’ll pay a lot more interest to the bank with a 30 year mortgage. That’s obvious, but how obvious? Let’s compare some numbers.

Compare 30-Year and 15-Year Mortgage Interest

Let’s say you bought a $200,000 house today and put 20% down. Your mortgage would be $160,000 and for the sake of simplicity let’s assume you paid your closing costs out of pocket. You have two options: a 30-year fixed mortgage as 3.88% or a 15-year mortgage at 3.15%. (Those are the national averages for those products as of today according to Bankrate.com. Your actual mortgage would likely be based on 1/8ths. Instead of 3.88% it would be 3.875% since that is 7/8ths. We’ll stick with the averages for sake of simplicity.)

Here is how your payment and interest breaks down for each of those loans:

  • 30-year: $752.75; $111,021.32
  • 15-year: $1,116.43; $40,971.78
  • Difference: ($363.68); $70,049.54

I hope those numbers stun you. The cost of the 30-year mortgage is almost triple what the 15-year will cost you in interest. That’s why your loan officer is so happy to offer that loan to you.

How I Rank Mortgages

So should you disregard a 30-year mortgage entirely? Of course not, but it is no longer on the top of my list.

Here’s how I would rank mortgages now:

  1. 15-year fixed rate mortgage
  2. 30-year fixed rate mortgage paid like a 15-year fixed
  3. 30-year fixed rate mortgage
  4. Adjustable Rate Mortgages (ARM)
  5. All others: interest-only, 100% financing, etc. (Usually no longer available)

Imagine what you could do with 180 mortgage payments. Is the couple hundred dollars you save on your mortgage with the 15 extra years you have to pay?

{ 4 comments }

Zack Jones March 12, 2012 at 8:34 am

When we refinanced recently we went with 30 year fixed and right now I’m gald we did. We pay a tiny bit extra each month but plan to eventually start making double payments come Jan 2014. It will take us that long to pay off all consumer debt and fully fund the emergency fund we want to have. For us the difference between 30 and 15 year loan was about $600 per month and we just didn’t have the extra $$$ to swing it. We could now but couldn’t at the time we refinanced.

Golfing Girl March 13, 2012 at 7:24 am

Zack,
Out of curiosity, why did you buy a house when you don’t have a fully funded emergency fund and you have consumer debt?

As for us, the difference between the 15 and 30 year was only about $300/month and it saved us $90,000 in interest. It was an easy decision for us–a guaranted rate of return plus 90K saved.

Bethy @ Credit Karma March 15, 2012 at 1:31 pm

Thanks for doing the math. My husband and I still aren’t close to buying a home. (Darn Bay Area housing costs.) But it’s great to keep these numbers in mind as we keep saving up that down payment.

Less for the Govt February 13, 2013 at 12:20 pm

I have options for refi of $285,000 loan of 15 years at 3.125 or 30 at 4.125.

My question is how do $ paid in total, interest paid and future value of the money paid and tax savings for interest relate?

I know I will be paying approx. 210,000 in interest if I keep the house for 30 years. However in 30 years what will 210,000 be worth.
What will a $500,000 house (current value) be worth in 30 years?

Could I do better things with the $440 per month lower payment that I currently pay? and what is the future value of that money?

Thanks

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