Mortgage: 30Y vs. 15Y

Water Cooler
#1

Preparing to buy first house, considering mortgage options.

It seems like with regard to 30Y vs. 15Y mortgage, the optimal decision may be to take a 30Y and just put myself on a 15Y payment schedule – which would capture most of the savings associated with doing a 15Y (excluding the rate benefit, obviously), but still maintain the flexibility of pulling back on payments in event of hardship.

i.e.

30 Year 4.75% mortgage for $200k house (I live in the midwest, this is our first house, and the daily volatility on my muni bond portfolio is significantly lower than many of you) would put ultimate cost at ~$376k.

15 Year 4.75% (i.e. taking 30 year, paying off on 15 year schedule) would put ultimate cost at ~$280k).

15 Year @ 4.00% (rough estimate of rate benefit from 15-year term) would put ultimate cost at ~$266k – but with significantly lower flexibility.

So you capture ~87% ($376k - $280k = $96k) of the total potential savings ($376k - $266k = $110k) based on term, and leave 13% of the potential savings on the table as a premium for the added flexibility.

Is this a reasonable way to think about this? Are there other perspectives I should be considering? First time actually thinking about mortgage math as a consumer. Thanks in advance for pointing out the holes in my logic.

#2

look at your itnerest rate net of taxes. 4.75*.75 = 3.56%. Do you think you can outearn 3.56%?

If you can outearn it, i suggest you borrow as much as possible. for as long as possible. paying the minimum amount.

you are prolly eligible for fha loan, which net would prolly add 50 bps net to 4% per year. but allow you to put 3.5% down vs 20%. for a 200k loan. thats 7k vs 40k, or 33k upfront savings but will cost you 1k/year (200000*.005)!

#3

Your theory makes sense. You will pay a higher rate for the 30y as opposed to 15y loan. However, the yield difference is not that large at the moment, especially after mortgage interest deduction, and you are effectively buying an option to not prepay your principal, which has real economic value. I think I would do the same.

#4

I think 30 Year and Prepay is the way to go. But I am a big fan of low required monthly payments.

#5

You mentioned this is your first house. Any idea as to how long you think you will live there? Just a thought but if you have any inkling that this might not be that long, if you decide for the 30 yr mortgage, you may want to consider a 5/1, 7/1 or 10/1 ARM. You get the same flexibility with lower required payment but also with a lower rate. But if you really do think you will live there a bit, then go with the fixed.

Also, in terms of your thinking, I’m not sure about the comparisons. To me, it sounds like you are paying off in 15 years either way, barring some unforeseen circumstance. As such, you want an option in case something happens. So from my POV, your comparison is the 280k vs 266k, with the question being “Is the flexibility worth the cost of the 14k option?”.

Keep in mind that assuming you go the 30 yr route and you start paying on the 15 yr schedule but have to stop that at a certain point because something did happen, you aren’t going to get to the 376k because of the extra prepayments you’ve already made. The total cost would be somewhere between 280k and 376k. That number, whatever it is, would be what you may consider, not the 376k. The 376k is only if you make all 360 payments as scheduled (a rare thing in general), which you are implying you won’t do, so it is irrelevant in my mind.

Another thing is that it sounds like you want to be debt free ASAP and as such, sounds like you are ruling out refinancing in the future (either to lower the rate or cash out equity), correct? Only bring this up because when we hit another recession, rates will go down. Let’s say that happens in 5 yrs after you get the loan. If the 10 yr fixed (there are some lenders that offer this) rate is 3%, would you consider refinancing then? Don’t mean to complicate things but just want to put it out there for you to consider.

Final thought, rates are still historically low. Just some perspective, back in 1998 when I finished undergrad, the 30 yr fixed was around 7% and people were all talking about refinancing at such a low rate. Who knew, right?! As such, I would put thought to what Nerdyblop said above.

Good luck with everything, I remember buying my first place. So happy to not be renting!

#6

^what he said. plus, if you are reasonably secure in your job and are not buying more house than you can afford, then leverage is your friend. lastly, if you’re young and your budget is roughly $200k for a house, then stop investing in munis…lousy way to compound capital.

#7

yep, 30 year mortgage rates in the 1980s was around 18%, sure inflation was around that much, but eventually inflatuion sunk, and these people who bought at that rate have prolly refied numerous times and taken equity out.

right now the exact opposite might occur. you borrow money at say 3.5% fixed for 30 year. and inflation goes up to say even 8% per year, and you just inflated your debt away. your principal will remain fixed, but the amount rent you would charge/pay would have risen exceeding that monthly payment.

the main issue is when you decide to upgrade. most people sell, which means they pay off their amazin mortgage deal. instead you should rent it out, depreciate it so you incur no rental income, and if you need the money, refi it out on a second mortgage.

if i was a gambling man, id bet on inflation, knowing that our government is pretty levered, they going to inflate their debt away too.

#8

All very helpful thoughts, thanks everyone!

Totally get the rationale of taking advantage of the opportunity to lever up – that isn’t the natural perspective I tend to take on my personal life, much less the roof over my family’s head. But it is certainly valuable insight.

#9

If you ain’t compounding at 30% you ain’t doing it right

#10

Leverage is good for absolute expected returns, but most people are probably taking excessive risk by leveraging a house that costs more than their net worth. For instance, apartment prices in NY are likely down 10% YoY for the same unit, after mortgage and tax changes. I can’t imagine what the change is if you bought a high tax house is Short Hills or somewhere like that. Anyway, if you paid 20% down and selling costs are 7%, you would lose almost your entire investment if forced to liquidate. If you can afford that risk, then whatever, but lots of people can’t.

#11

Did you adjust this for the home interest deduction? That is guaranteed money, so we discount the present value at the risk free rate of Fed Funds. Suddenly your networth is positive again. Right Nerdy?

#12

personally i would not buy right now. but if i did buy, i would do an fha loan simply cuz its a lower down.worst case all you do is pay 3.5% dp and 1% upfront pmi. prolly 1% for closing. so about 5.5%. if markets tank and you are unable to pay, default, you get to live for free a year b4 eviction. rent will prolly cost you that much at the very least. plus ca loans are non recourse. your credit will be shot. but guess what , if you couldnt make your payments, it’ll prolly take you awhile to save for a downpayment anyways. you should only put a lot down if you are confident in your cash flow.

i know the idea to strategically default is ridiculous, but as a borrower, you actually have power over the lender. you can make them renegotiate the entire deal when things tank. they will prefer that you actually renegotiate rather than have you default and have them take ownership.

#13

Nery, you know that in France, you can live 1y free with no rent? It’s because French people cannot be evicted during cold months, which is like 6m, and the eviction buffer is like 6m to protect renters. So effectively, you cannot be kicked out for 12m. Seems relevant.

#14

right before defaulting on your mortgage take out a HELOC and go all in on muni CEFs while then going rent-free for 12 months.

#15

I agree with the others - get 30 year. Then, if you want to pay it off in 15 years, then just pay an extra 20% every month.

#16

While I typically wonder how Nerdy (who seems smart) comes up with really silly ideas, the FHA thing is interesting because the mortgage is assumable. I actually took out an FHA loan before they changed the requirement to lifetime PMI in part due to the assumption clause. I figured if rates rose a lot, the ability to get the loan at such a low rate would be attractive. Turned out rates have stayed low forever and I’ve paid down quicker than schedule, but I think my loan may be 50-100bps below market at this point. That should be able to net me a higher sales price all else equal, but the benefit isn’t much. Fingers crossed long rates go up!

#17

Not a fan of FHA because of the lifetime PMI. At least with a regular conventional loan, if you put 5% down, you can get the PMI removed once you get built up 20% equity.

I do wish mortgages in the US had some of the characteristics of those from other countries. I’ve always like the portable feature of the Canadian mortgage where you can use the balance of the mortgage on your old home towards your new home and then get a 2nd mortgage to cover any extra if you are buying a more expensive place.

Also, for those of you that live in some of the judicial foreclosure states (ex. NY, NJ, MA), you can easily beat France. Even now in I think in NY or NJ, it is literally taking them 2-3 yrs do a foreclosure from start to finish.