Out of all the mortgages out there, a 15-year mortgage will likely save you the most amount of interest. 15-year mortgage rates are almost always lower than 30-year fixed mortgage rates.
Further, because the mortgage fully amortizes across a 15-year duration, you will likely pay off your mortgage sooner than if you had a 30-year amortizing mortgage.
If you want to save on mortgage interest expense, getting a 15-year mortgage is your best bet. You can always pay extra principal down as well.
15-Year Mortgage Versus ARM
Ever since I purchased my first property in San Francisco in 2003, I’ve actually preferred adjustable rate mortgages (ARMs). I preferred an ARM over a 30-year fixed mortgage because the interest rate was always lower.
In addition, given my consistent belief that we’d be in a permanently low interest rate environment, it didn’t make sense to borrow money on the long end of the curve.
In a permanently low interest rate environment, when an ARM resets, there’s a good chance it resets to a similar rate or even to a lower rate. Further, the average homeownership tenure was only about 7 years in 2003. Today, post-pandemic, the average homeownership tenure is closer to 10.5 years.
But even still, taking out a 30-year fixed rate mortgage makes no sense if you plan to sell your home after 10.5 years. Strategically, you want to match your fixed rate with your homeownership tenure to save the most amount of money.
But after so many years of taking out mortgages, refinancing them, and paying them off, a 15-year mortgage is probably the best mortgage to get, if you can afford it.
Benefits Of A 15-Year Mortgage
Below are the benefits of a 15-year mortgage versus a 30-year mortgage and an adjustable rate mortgage.
1) 15-Year Mortgage Is Low
Back in normal times, a 15-year mortgage generally had an average rate in between a 30-year mortgage and an adjustable rate mortgage with a 1, 3, 5, 7, or 10-year duration. The reason why is that shorter-term loans are less risky and cheaper for banks to fund than long-term loans.
Put yourself in the banks’ shoes. If someone wanted to borrow money and pay you back in 30 years, you would likely charge a higher rate due to the time value of money, inflation, and the risk something happens to the borrower before the 30 years is up. On the other hand, if the borrower asked to borrow money and pay you back in a month, you might not bother to charge an interest rate.
Below is a graphic of the Treasury yield curve that demonstrates higher rates with longer durations. In normal times, a yield curve is upward-sloping.
As an investor, you’ll usually get a higher interest rate if you invest in a 30-year Treasury bond versus if you invest in a 10-year bond and so forth. As a borrower, you’ll have to pay a higher mortgage rate for a 30-year fixed versus a 15-year mortgage or an ARM.
Yield Curve Examples
Below is an example of a normal-sloping yield curve in 2021.
Below is an example of an inverted yield curve in 2022. Due to the inversion, it is actually better value to borrow at longer durations given rates are lower. Hence, all the more reason to lock in a 15-year fixed rate mortgage or 30-year fixed rate mortgage. You can always refinance when rates go down again.
Take Advantage Of Mortgage Kinks
We experienced a mortgage market anomaly where the average 15-year mortgage was much lower than the average 5/1 adjustable rate mortgage. And whenever there is a mortgage market anomaly, you should take full advantage to save the most amount of money.
Take a look at the Freddie Mac mortgage market survey below from July 2021. It shows the average 15-year mortgage was 2.2% versus 2.52% for a 5/1 ARM. However, it’s worth noting the average fees/points is slightly higher for a 15-year mortgage than for a 5/1 ARM.
Starting around early 2019, the average 15-year mortgage rate average began to consistently fall below the average 5/1 ARM rate (green line lower than orange line). The reason? A focus on risk-adjusted profits and supply and demand.
Lenders decided they couldn’t make enough margin on a 5/1 ARM with a 30-year amortizing period to warrant the increased risk of defaults. Therefore, the average 5/1 ARM rate didn’t decline as much.
Instead, lenders began focusing on 15-year mortgages to tighten lending standards and increase their chances of getting paid back in full. With a higher monthly payment and a 50% shorter amortizing period, lenders felt more comfortable lending 15-year mortgages at lower rates.
At the same time, borrowers have decided they wanted to be more conservative and take out a shorter amortizing loan instead. With interest rates so low, why not lock in a loan for 15 years instead of only five years.
Lenders Are Still Very Cautious In 2023+
Only those with excellent credit scores are getting approved for mortgages and mortgage refinances. This lending stringency is one of the key reasons why the housing market won’t crash any time soon. Great credit plus massive home equity gains provides a tremendous amount of cushion.
By keeping the 15-year mortgage rate so much lower than other mortgage products, the lenders are willing to give up some margin to secure longer-term profitability in an uncertain future. In other words, lenders are willing to sacrifice some margin for the added security of receiving higher payments over a shorter amortization period.
This is where you need to take advantage of the kink in the mortgage lending curve. As the economy continues to improve, the gap between the average 15-year mortgage rate and the average 5/1 ARM rate will likely narrow.
The next time this mortgage market anomaly happens, you must take advantage!
Unfortunately, as of today, the 15-year fixed rate mortgage is now the same or higher than the average 5/1 ARM. Therefore, you’ve got a harder decision to make. That said, well-qualified borrowers are still getting much lower rates than average. Make sure to shop around online.
2) A 15-Year Mortgage Borrower Pays Less In Total Interest
Since a 15-year mortgage amortizes over 15 years instead of 30 years, you will pay less total interest if both mortgage rates are the same. However, the average 15-year mortgage rate is much lower than the average 30-year mortgage rate. Therefore, the combination of a lower rate and shorter amortization period results in much less in total interest payments by the borrower.
Let’s look at the following total interest paid over the life of a $1 million mortgage with three types of terms.
30-year mortgage at 3%: $517,777 in total interest paid
15-year mortgage at 2.3%: $183,347 in total interest paid
15-year mortgage at 5%: $423,428 in total interest paid
Even if you took out a 15-year mortgage interest rate that was 2% higher than a 30-year mortgage rate, you would still end up paying $94,349 less in interest during the duration of the loan. The power of compounding works both ways.
3) A 15-Year Mortgage Causes Greater Forced Savings
Forced savings is one of the reasons why the average net worth for a homeowner is more than 40X greater than the average net worth of a renter. Once you give someone an option to do something, the conversion rate is guaranteed to be lower than 100% (forced).
If the government didn’t force W2 earners to pay taxes out of each pay check, the government would be in a huge deficit if it depended on citizens to pay once a year.
Given the shorter amortization period, the monthly payment for a 15-year mortgage is much higher than a 5/1 ARM or 30-year mortgage amortizing over 30 years.
For example, a $1 million, 15-year mortgage at 3% has a monthly payment of $6,905. A $1 million 30-year mortgage at 3% has a monthly payment of only $4,216. This is a monthly difference of $2,689 for borrowing the same amount at the same rate.
In addition, if you take out a 15-year mortgage, a greater percentage of your payment will go towards paying down principal. With a $1 million, 30-year mortgage at 3%, $1,716 of the $4,216 monthly payment (40.7%) goes to paying down principal. With a $1 million, 15-year mortgage at 3%, $4,405 of the $6,905 payment (63.8%) goes to paying down principal.
In other words, every month, the 15-year mortgage holder is forced to save $2,689 more than the 30-year mortgage holder in this example. Over time, this forced savings really adds up. And if the house also appreciates over time, then an enormous amount of wealth can automatically be built.
4) Pay Off Your Mortgage Quicker With A 15-Year Mortgage
Some people who take out ARMs or 30-year fixed mortgages like to tell themselves they will pay off the mortgage sooner. Having lower monthly payments and the option to pay off their mortgage sooner is a nice combination. However, in my experience, I’ve found we seldom stick to our mortgage payoff intentions.
For example, in 2003, I had a goal of paying off my 30-year fixed mortgage in 10 years. But I ended up refinancing the property after one year to a lower 30-year fixed mortgage. Then I wised up and refinanced the mortgage to an ARM several years later. Instead of paying off the mortgage in 2013 as planned, I paid it off in 2017.
Not only was I tempted by my new lower mortgage rate, I simply didn’t pay down extra principal as regularly as I had anticipated.
With a 15-year mortgage, you can be the most unfocused person. You are guaranteed to pay off your mortgage in 15 years if you keep making your payments.
5) Potentially Less In Fees Due to Fannie Mae And Freddie Mac
If your mortgage is purchased by one of the government-sponsored companies, like Fannie Mae, you will likely end up paying less in fees for a 15-year loan. Fannie Mae and the other government-backed enterprises charge what they call loan-level price adjustments that often apply only to, or are higher for, 30-year-mortgages.
These fees typically apply to borrowers with lower credit scores who make down payments less than 20%. Private mortgage insurance (PMI) is required by lenders when you make a down payment that’s smaller than 20% of the home’s value.
If you find yourself in this situation, you will pay lower mortgage insurance premiums if you take out a 15-year mortgage.
Disadvantages Of A 15-Year Mortgage
Taking out a 15-year mortgage or refinancing into a 15-year mortgage makes a lot of sense. However, a 15-year mortgage is only great if you can afford it. Here are the three main disadvantages of a 15-year mortgage.
1) Higher Monthly Payments
Because a 15-year mortgage amortizes over 15 years, a 15-year mortgage will have higher monthly payments than a mortgage that amortizes over a 30-year period. Being able to pay $6,905 a month for a $1 million, 15-year mortgage at 3% requires a much higher income than paying $4,216 a month for a 30-year fixed mortgage.
If we are to follow my 30/30/3 rule for home buying, a 15-year mortgage holder in this example would need to earn at least $250,000 a year (($6,905 X 3) X 12). Whereas a 30-year mortgage holder with the same terms would only need to make at least $152,000 (($4,216 X3) X 12).
In other words, the 15-year mortgage holder needs to make about 61% more, despite borrowing the same amount.
Of course, someone who makes $152,000 could still pay $6,905 a month in mortgage payments for a 15-year mortgage. The disposable cash flow will simply be tighter.
2) Less Affordability (Biggest Disadvantage)
Less affordability to buy the home you want is the biggest disadvantage to taking out a 15-year mortgage. Let’s go back to my 30/30/3 home buying rule that states you should buy up to 3X your household income.
A $240,000 a year household can afford to buy up to a $720,000 home. If the household wants to stretch the multiple from 3X to 5X given rates are so low, the household can afford to buy up to a $1,200,000 home. However, the household needs to be damn sure about its income-generating future and ability to hold on during bad times.
A $240,000 a year household earns $20,000 gross a month. Based on my 30/30/3 rule, up to 30% of the monthly cash flow should be allocated to a mortgage. Hence, a mortgage of $6,000 is what is considered affordable for a $20,000 a month earner. $4,216 a month for a 30-year, $1 million mortgage at 3% is not a problem. However, $6,905 a month for a 15-year, $1 million mortgage at 3% doesn’t work with my rule.
Borrowing Less Due To A 15-Year
Therefore, in order to take out a 15-year mortgage, the $240,000 a year household can only borrow $865,000 at 3% for a payment of just under $6,000 a month. Borrowing $135,000 less means coming up with $135,000 more in cash or buying a cheaper home.
Instead of buying a $1,200,000 home with a $1 million mortgage, the household buys a $1,000,000 home with an $800,000 mortgage. If the house appreciates by 5% over one year, the household loses out on $10,000 in appreciation by buying the cheaper home. Over a 10-year period, the household loses out on a significant $125,778 in appreciation/equity.
In a bull market, you want to buy the most home you can afford. In a bear market, you want to do the exact opposite and rent. A 15-year mortgage will limit you to buy the most you can afford.
3) Less Money Going Towards Savings Or Other Investments
A higher monthly payment for a 15-year mortgage requires higher income and higher cash reserves. Therefore, your emergency fund or cash reserves will have to be higher to cover your higher monthly burn rate.
A higher cash reserve means less money going towards saving for retirement. Greater cash flow means funding a college 529 savings plan. You can also spend more on wants.
Every dollar has an opportunity cost. A 15-year mortgage has a higher opportunity cost, especially when times are very good. For example, if the stock market ends up going up 20% a year for the next three years, you may have preferred to get a 30-year amortizing loan and invest the extra cash flow instead.
Personally, I like investing in commercial real estate through a diversified fund like the ones from Fundrise. Commercial real estate is the asset class I think has the most amount of upside as the economy opens up. Fundrise manages over $3 billion and has over 350,000 clients.
A potential steady annual return of 5%-8% seems reasonable. It would make up for some of the savings by not getting a 15-year mortgage.
However, nobody knows for sure how their other investments will perform. Therefore, it’s a good idea to spread around your cash flow.
The Ideal Situation To Take Out A 15-Year Mortgage
If I was forced to take out a 15-year mortgage back in 2003, I likely would not have bought the condo when I did. The increased monthly payment would have perhaps been too much. Therefore, I would have probably waited at least another year and lost out on a $46,400 paper gain. From 2003 – 2004, the San Francisco real estate market went up about 8%.
To save $46,400 in interest expense with a 15-year mortgage that is 0.5% lower than an ARM, it would take nine years and three months with a $1 million loan. In other words, among other things, take into consideration the future of the housing market when choosing the type of mortgage.
For first-time homebuyers, it is probably best to take out an ARM. Then consider a 30-year fixed mortgage to get neutral the real estate market.
In the past, I’ve written the best time to buy property is when you can afford it. Shorting the housing market by renting long-term is a tough way to build wealth. Inflation is too powerful of a force to go against.
Veteran Owners Should Get A 15-Year Mortgage
O you’ve built up some home equity and grown your savings, it’s worth refinancing to a 15-year mortgage. Alternatively, take out a 15-year mortgage for your next home. Over time, your income and wealth should naturally grow. Therefore, you will more easily be able to afford a higher monthly payment.
If the average 15-year mortgage rate was only 0.25% or less than the average 5/1 ARM, a 15-year mortgage might not be that attractive. But at an average discount of 0.5%, it is too wide of a spread not to pounce. And if you can get a relationship pricing discount, even better. Although, having to move a lot of funds for relationship pricing can be a real PITA.
Always take advantage of a 15-year mortgage when its rate is lower than a shorter duration ARM. This anomaly won’t last forever.
A Race Against Time
15 years goes by pretty quickly. Let’s say you bought your second primary residence, a forever home, at age 32. Having a fully paid off home by 47 is pretty sweet.
Once you don’t have a mortgage, life gets much more affordable. Suddenly, the idea of retiring early, taking a long sabbatical, or working a more interesting but lower paying job is more feasible. With all the extra cash flow, you could invest, live it up, or do both.
Surgically Invest In Real Estate
Real estate is my favorite way to achieve financial freedom. It is a tangible asset that is less volatile, provides utility, and generates income. By the time I was 30, I had bought two properties in San Francisco and one property in Lake Tahoe. These properties now generate over $150,000 a year in passive income.
In 2016, I started diversifying into heartland real estate to take advantage of lower valuations and higher cap rates. I did so by investing $810,000 with real estate crowdfunding platforms. With interest rates down, the value of cash flow is up. Further, the pandemic has made working from home more common.
Take a look at Fundrise, my favorite real estate investing platform for both accredited and unaccredited investors alike. Fundrise has been around since 2012. The platform has consistently generated steady historical returns, even during down years in the stock market.
For most people, investing in a diversified real estate fund is a great way to gain real estate exposure.
For those of you who are accredited, also take a look at CrowdStreet. CrowdStreet focuses primarily on real estate opportunities in 18-hour cities. 18-hour cities have lower valuations, higher cap rates, and generally have higher growth rates due to positive demographic trends. You can build your own select fund with CrowdStreet.
A 15-Year Mortgage Will Save You The Most is a FS original post.
30 year and choice of what to do with the difference in payment with a 15 year is better. If choosing to pay extra principle you will pay off faster but investing the cash in dividend aristocrat stocks instead will also build a passive income stream that will outlast the fixed amount of interest saved from instead paying off loan principle.
My husband and I are debt free (paid off the house early a couple of years ago). Now, we are building our future retirement home on land we have owned for several years. The plan was to originally stay in our paid off home but soon realized that one story living and a more energy efficient home was better for us. Our current home is over 100 years old, renovated 25 years ago but now needs many updates. It is not the most optimal time to build due to the expense of materials and labor but we will be able to do some of the work ourselves to save on the costs. So the biggest decision will be to decide how much of the proceeds from the sale of our current home we will put towards the new mortgage and the loan term we will take out. I have changed my tune on a paid off mortgage with interest rates so low.
Long time reader, first time commenter, I just last Friday paid off my 15 year mortgage in 9.5 years by myself. I am now officially debt free and it feels great. I have also contributing to my 401k and Roth savings accounts. I’ve always lived beneath my means, practiced self denial, and shopped the clearance rack. :) I highly recommend getting a 15 year loan(or less). I hope to meet with a financial advisor in there near future and start figuring out other ways to invest. Any other recommendations for my next financial steps?
My primary home is also full of 4 tenants/roommates and I’m about to refinance. It’s my only property and I want to buy more as soon as possible, but I’m leaning toward keeping it 30 year so I can afford to qualify for the most more in future purchases (as well as DTI, cash flow, interest tax deductions) . I ideally will keep this property forever and continue to purchase more, hoping eventually to get into multi-family and/or commercial.
Given these, would you recommend 30 or push more toward 15? I’m trying to get some kind of measure of when it would make sense, and my only guess would be if the 15 delta in rate would be greater than what I could make elsewhere, which seems unlikely. But please correct me if I’m not thinking right :-).
For an investor beginning to get into real estate, it is best to have more cash reserves, so I would opt for the 30 year. You’ll need the cash for down payments and to cover expenses when things don’t go according to plan (tenant not paying rent, unexpected major repairs, etc.).
If a 15 is better than a 30 with half the interest rate then why not a zero year mortgage? In short, for folks that can afford to do so and FS, why not just pay your mortgage off since given your capital you can afford to and any mortgage is essentially leveraged debt.
Conversely, why isn’t the 30 a better option since you are essentially leveraging with negligible higher rates given the time consideration?
I’m speaking in strictly monetary terms – I understand the psychology of each. Asking for a friend…
I think you’re right about this. The whole point of real estate is leverage and if you lock up more capital in real estate than needed you really end up crippling your investment returns. Best case is to use the bank’s money for real estate and then your capital in stocks or other higher yielding investments.
You are absolutely correct. I’m a long-time reader and achieved FIRE at 40. I’m a big fan of Sam, but this is one area where he and I definitely disagree. I do not believe in paying off one’s mortgage at these low rates. One should borrow as much as possible for as long as possible and invest elsewhere the extra cash for higher returns. Why tie up all that equity in an illiquid asset like your home? In my last refi, I switched to a 10 year interest only, 30 year amortization loan.
For a added risk, I do agree with Sam’s approach of using an ARM if the rate spread between that and the 30 year mortgage is big enough. It’s been the right bet for him.
That’s the beauty of personal finance. Everybody has their own personal preferences.
At some point, you may have so much money that the debt becomes an annoyance and trying to always maximize returns is no longer necessary. Maybe that net worth level is $3 million for some or $20 million for others.
Even FIRE has many different levels.
I remember going from an ultra-conservative (stupid) interest only loan in ‘06 to a 30-year loan a year later. Then, a 15-year loan a couple years later to a 10-year loan at year 10. In hindsight, I’ve realized the larger payments always seem to be easy to adjust to and over time the payments seem less and less impactful. In the end, we will pay off in 20 years (5 years from now) at 2.75%. 20 years is not bad considering the time we wasted initially when our income was 25% of our current income. Now, I wonder if we should buy up, but things are so comfortable having 2K plus go to principal every month ($300 in interest). However, I wonder if the appreciation on a more expensive home would actually produce better gains than the forced savings of 24K annually. 48 years old and will want to purchase the forever home at some point. Will retire at 63 to maximize pension. Current home worth about 750K and owe <140K. Long-term plan was to get a 15 year on the forever home at 50 to coincide with retirement. Must decide to keep current or sell to go all in on the forever home. Hmm…