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.
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. If there’s any time to get a 15-year mortgage, it’s right now.
1) 15-Year Mortgage Has The Lowest Average Interest Rate Today
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 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.
We Are Not In Normal Times
However, we are in a most interesting time. We are currently experiencing a mortgage market anomaly where the average 15-year mortgage is 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 latest Freddie Mac mortgage market survey below. It shows the average 15-year mortgage is 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 Today
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, as a savvy Financial Samurai, 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 gap will likely continue to narrow until the average 15-year mortgage is eventually higher than the average 5/1 ARM rate.
If the average 5/1 ARM rate stays static at current levels, I could see the average 15-year mortgage rate increase by 0.5% to 2.75% a year from now. In other words, you are getting a 0.5% DISCOUNT by refinancing to a 15-year mortgage rate today.
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.
For example, 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) 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
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
So far, all of you should be in agreement that 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.
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.
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, funding a college 529 savings plan, investing in other assets, and spending 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.
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, followed by 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
However, once you’ve built up some home equity and grown your savings, I think it’s worth refinancing to a 15-year mortgage or taking 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.
In an environment where the average 15-year mortgage rate is lower than the two other main types of mortgages, taking advantage of this anomaly is smart. It 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.
If you’re looking to get a 15-year mortgage, check out Credible, my favorite lending marketplace. You can get no-obligation quotes in minutes. The more you shop around, the more you can save.
Surgically Invest In Real Estate
Real estate is my favorite way to achieve financial freedom because 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.
Readers, any of you take out a 15-year mortgage? Why do you think people are still taking out 30-year fixed mortgages in today’s environment?
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…
Excellent article.
Per your advice, I refied through Credible.
Dropped a whole point for under a $1000 in cost.
Also went with a short loan duration also.
Saving a whole 1% is huge! Congrats! I’m in the process of shopping around now for two mortgage. Can’t believe we can still save today after rates ticked up from 2020’s bottom. But mortgage rates have been falling again over the past three months. Now is definitely a good time to look.
Have 3 mortgages, 2 of them on rental properties. Selling Primary residence this month and getting enough cash to pay off the 2 rental mortgages from closing. Thought was to refi one of the rentals with cash out 30 yr fixed to get another 100K to put all the cash towards building a house and have smaller loan on the new house build.
Should I take it in another direction and just payoff all loans, then build what we can with cash, and take construction loan out as needed?
Was trying ot hedge inflation by locking in a 30 yr fixed at low rate. Other wild card is selected 3 points fee to buy down rate to 2.5%. Plan to own for 10 years, so the buy down is worth it if we keep for 7 years and don’t pay off early.. But no mortgage would be nice too..
Have a house with a 30 year mortgage. My wife and I just paid off most of our debt and she just got a new job with a raise so we’ve been considering a 15 year. I went to check out Credible and they’re not yet available in NY. So I’ll be visiting the credit union I work for to get a 1% employee discount on the mortgage rate.
I appreciate this post and the comments. With so many people recommending the 15 year mortgage, I am seriously questioning my choices to go with 30 year mortgages. I have 3 properties total, 2 rentals and a personal residence. My idea is that I want to keep the cashflow requirements low so that I can deploy extra cash to investments of my choosing. That may be additional properties or the ability to move and purchase a new primary residence in another city without having to sell my existing.
I suppose one can refi and take money out of property again if needed but that itself comes with additional cost.
I also saw a 30 year mortgage as an inflation hedge, essentially shorting a 30 year debt instrument. If inflation rises, my debt payments remain the same and the amount I owe goes down in inflation adjusted terms.
Your posts contain much wisdom though and I don’t want to ignore that. So I’m wondering if folks agree with my rationale.
Rentals I think make more sense to stick with a 30 year because the interest expense is a good tax and you can improve your cash flow to buy more rentals and lower DTI calc as well. Primary home – most people aren’t able to deduct the interest anymore with standard deduction. But it really just depends on the interest rate spread, risk tolerance on cash flow now and in the future, and how aggressive you want to lever up rental properties. There is a limit of ~10 homes you can finance with Fannie/freddie, so it may make sense to have 1 or 2 of your rentals be 15 year to pay off more quickly to have another loan handy down the road as your portfolio builds out.
I took out a 5/1 ARam mortgage on my current home when i bought is 5 years ago at 3%. It recently adjusted down to 2.75%. While I considered refinancing, I can’t justify those costs given how low I am. I have the funds to pay of off early, but had wanted to keep cash with hope of property in Florida to make up for/regretting selling in 2016 when my job moved me from there.
Excellent! Yours is a great example of what I’ve been writing about for a while, regarding ARMs resetting to equal or lower rates for the past 40+ years.
I would just keep your mortgage as well.
i Disagree. you didn’t factor into tax benefits on interest and extra money saved for addiotnal investment. With a high inflation environment, better to borrow money and save up for additional rental property investment opportunities.
We’ve recently paid off our mortgage. In hind sight we should have taken a 15 year loan out to get a better interest rate. So I will admit we likely lost money. The good thing, we only carried our mortgage for 20 months. :-)
I’m trying to get my wife to come on board on refinancing our primary residence to a 15 year as well, we got our mortgage just last year in March 2020, a 30 year at 3.15% for $595K for which we had 20% downpayment, so the balance we have now remaining is $454K to refinance, with current PITI of $2,930/mo.
We’re in our mid 30s. I’ve already gone through the initial applications with 2 lenders to lock in 15 year at 2.00% with no points and minimal closing costs (just about $1K). I’m running and running the numbers to convince her that we can afford increased PITI of $3,845/mo (right under 28% of our gross monthly pay), so that we’re being smart and optimal about our purchasing power to pay down the biggest debt which is this mortgage.
We fortunately have no student loans, her car is paid for, I just bought out my auto lease of $17K for a 4 year loan at 2.39% that I can easily pay more per month to pay it off in 3 years if needed, and my rental condo (I refi to 15 year back in 2015, so 9 years left at 3.00%) is effectively paid for by the monthly rent.
Between 401K and IRA, I’m already putting away 20% of my income to retirement. My wife is a bit on the conservative side when it comes to spending (a good problem!) and would rather have the cash handy (although we already have 12 mo expenses between our checking and savings), so not sure why else she’d want to hold on to the cash unless to invest in market.
Doesn’t our numbers look great to pursue this aggressive plan? I might get her to compromise on a 20 year instead just for her to feel safe about cash flow, but continue to sock the extra away to mortgage or invest in the market. Could use your validation that this is indeed the right path to go down!
A 1.15% interest rate savings is HUGE. The general rule is to refinance if you can save 0.5% or more and break even within 12-24 months. But with no fees and a 1.15% savings, refinancing is simply a no brainer. With the payment under 30% of gross, you work within my 30/30/3 rule for hole buying as well.
Your income should go up as well. I say refinance to a 15-year. And don’t forget to get a 30-year term life insurance policy as well, as you are at the ideal age.
GL!
Would maxing out both you and your spouse’s 401k and Roth IRA and HSA (assuming your both healthy) be a better investment than saving many thousands of dollars in mortgage interest? This is actually a simple math problem and many financial advisors have come to a consensus. I’d only add that Dave Ramsey sees this as a behavior problem, and therefore he strongly prefers a 15 year mortgage.
First off, great article!
Quick question:
I’m looking to buy my first home in the next year or so, but I am also planning on buying an investment property near the campus of the med-school my wife is going to to rent out and capture a piece of that market, ideally within the next 4 years or so.
With this current goal, would you still recommend the 15 yr mortgage or would a 30 yr mortgage be the better option due to the lower payments?
I’m currently leaning towards the 30 yr because of the lower monthly payments and reduced monthly payments would allow me to build up the down payment for the investment property that much faster, but being new to all of this I wasn’t sure.
Thank you for the help!
Mark
Hi Mark,
Donno your income. But getting neutral real estate in an area you want to live in for 5+ years is the priority, then the rental.
I concluded this post by saying go with a 30-year amortizing mortgage to get your ideal house, then for your next primary get a 15-year or refinance your existing mortgage to a 15-year as you get wealthier.
As a future doctor, your household income should really take a big leap in the future. That is probably when I’d start focusing on 15-year mortgages.
That makes sense. Thank you for the advice and quick response.
I cash-out refinanced last December into a 15-year fixed at 1.875% from a 30-year fixed. I’d highly recommend any readers seize this opportunity now if they have the cash flow to cover the payment. The interest rate on a 15-year is so low it’s practically free, or potentially negative in inflation-adjusted terms.
Current Best Rates I see using the quote aggregator I used last time:
30-year : 2.388%, $860 fees
20-year : 2.25%, $0 fees
15-year: 1.763%, $489 fees
10-year: 1.75%, -$499 fees (actually a credit)
The choice seems so obvious when you compare these options, there is a huge reduction in interest rate at the 15-year term.
WOW! Under 2% is huge. It’s a good reminder that the average rate for various mortgages are just that, averages. With good credit and good home equity, you can often get below the average. Shop around folks! Check online and call your existing bank.
Makes we want to refinance my 7/1 ARM at 2.125% that I just got in 2020. I’m going to check around now.
I just locked in 1.875% with -$2968 in fees (a credit) on 15 year on my main this AM (currently have a 5 yr ARM at 2.44%). Good call to you and Sam.
Amazing rate! Congrats Rob!
Thanks! Saves me 130k+ in interest (assuming no change in ARM rate)
After learning my stucco home had rotting sheathing, I opted to do a 20Y cash out refi in January to cover most of the $80K in renovations. The refi took my 30Y 3.375% fixed down to 20Y at 2.375%. All told, the new mortgage will only delay my original 30Y payoff by a few months. That includes the 80k in debt I added. The new rates are golden!
We went even nuttier. We refinanced to a 10 year and dropped 1.1 points. The fixed savings make it easy. We are socking away 7500 monthly tax deferred and 5000 cash, plus ROTH conversions at 60,000 to 80,000 yearly. We will forever be in the 24% bracket.
As we make the mortgage payment and stash cash, we will pay the mortgage off once the two hit the inflection point.
It’s boring but satisfying to see the progress. Mortgage melts and cash is ballooning. Certainly not the returns of AMC stock or dogecoin. But it is reliable.
Progress is my one word definition of happiness.
100% agree
Can you explain your Roth conversion? Im trying to figure out how you are saving money deferred, etc. This is all new to me, and a bit confusing. I too am looking for boring!
I’ll try:
With my current career I have a window to defer 90,000 a year into a 401a. At the end of the specified time (5 years) I have to separate from work – retire. The money is a deferred pension payment.
During this same time we are choosing to do ROTH conversions from pretax 457b accounts into ROTH 457b. $60,000 conversion is $14,400 owed in tax based on 24% bracket. The conversion is treated as earned income. The taxes are due each filing year as reported income.
I consider myself somewhat informed when it comes to investments but I have a hard time with the leverage concept. Even when you’re leveraging your money on real estate your still paying interest. I understand the math on leverage, but not paying interest is still better than paying interest IMO.
If leverage is so great how come we aren’t all buying stock on margin? Screw leverage, pay cash. I think whatever mortgage term gets you to pay off your loan the fastest is the best one to choose.
Some do for stocks. However, most do not because stocks are more volatile and more risky. With forced margin calls at often terrible times, the risk is greater and brokerages generally limit to 50% margin.
The lenders would only write a 10/1 ARM on my Condotel, but I pay it off like it is a 15 year mortgage. I have owned for 3.5 years and so far on track to pay it off in under 15 years. This gives me a little more cushion on my monthly payment as well. Hope to pay it off in 13 or years total.
I’m surprised you got a 10/1 ARM for a condotel mortgage in the first place! Perhaps the mortgage market is loosening up b/c I wasn’t able to refinance my condotel mortgage for years. And now, it’s really small, so I plan to pay it off within 12 months. Good job focusing on paying it off in 15 years.
I agree overall – I’ve always thought 15 year was the goal. The reason: the savings are in the bag – especially in an unprecedented time in history like now. Who knows when the market will go haywire. In your example, you bag $334,430 in interest by going with the 15 year. If you plug and chug that as FV, you would need to invest about a 1/3 (or $105,426) and get 8% annually for 15 years to catch up. I like the bird in the hand these days.
Look at Q2 2013 and the rate differential between 15 year and 30 year. At that time, it would be real hard to justify going with the 30 year and not biting the bullet with higher monthly payments of the 15 year.
I know you like the ARM, but what about if it upticks? I always thought that a decent # of folks get hammered by these.
Rates have been going down for 40+ years. I don’t expect rates to tick much higher.
With an ARM, there is almost always a maximum interest rate increase cap for the first year of reset (2% at most usually), and a lifetime cap (3%-4% at most). The vast majority of ARM holders saw a reset that was flat or down over the years.
And many ARM holders were able to refinance multiple times as well.
Related: The Anatomy Of An ARM Reset
We took out a 15 year mortgage due to lower interest rates and to force ourselves to have our home paid for by our target retirement dates. We are also paying extra to hopefully have it paid off in 10. There’s a a lot of psychological security in having the roof over your head paid for despite the ability to instead invest the money in the market.
Good! There is a definite psychological boost to paying off your mortgage for sure. Paying off your mortgage by the time you retire is like a satisfying accomplishment and gift to yourself. It really feels great.
My risk-averse profile makes me prefer the 15 year mortgage duration, less risk for the bank and for me.
One item I rarely see commented upon, regarding listing price for homes…the payment for a 2.5% 30 yr mortgage at $800,000 principal is $3,200/month. That payment of $3,200/month on a 5% 30 year would service $550,000. It always feels good when a leveraged asset you own increases in value. I don’t see this happening soon and hope it doesn’t, but I’ve been on the other side of that rolling boulder when the ‘increase’ becomes ‘decrease’. Inflation is a sticky wicket! *fingers crossed!*
I’m pretty confident the housing market is going to stay strong for years to come. The pace of appreciation will definitely slow, but I’m hard pressed to see negative YoY prices with structurally low supply and structurally high demand.
Readers, any of you take out a 15-year mortgage? Why do you think people are still taking out 30-year fixed mortgages in today’s environment?
We actually elected to get a new construction home recently under contract for fall close and have opted to pay in cash. This is my wife and I’s first home, and it’s on the smaller end, sqft and price range, so felt it was easier to just avoid the effort of dealing with a lender. It’s also a small-ish percent of our net worth (will be ~25-30% by year end), so the leverage benefit isn’t as meaningful nor would we save anything on the mortgage interest deduction, so the cash flow benefit of no payments except Tax/Insurance/HOA will be great.
We may consider a cash out refi or home equity line, but also may just wait until the next home in 3-6 years to have a mortgage.
I’m comfortable having my total home equity be ~30% or less of our net worth, so either got to juice the net worth or take out a mortgage for the difference. :)
Nothing wrong with being conservative. 30% of net worth is good. Real estate is about 35% – 40% of our net worth and it feels good to be diversified. However, real estate is where I’m most comfortable investing today. With so much funny money floating around, I want to own real assets!
Great article, Sam. I inadvertently turned a couple of 30 year mortgages into sub 15 year mortgages on some SFH rentals I purchased in 2010,2011, and 2012. Although they were 30 year mortgages, I paid 2 of the 3 off within 9 and 11 years by just adding extra principal each month as my income grew and I realized consistent occupancy in the homes.
In October, we bought our dream home and did a 30 year at 2.5%. I opted for the 30 because I feel like I can dedicate extra principal if I ever want to shorten the term, but more importantly, my 30 year mortgage is the exact amount of additional cashflow from 2 of the 3 rentals now owned free and clear. In essence, my 3 sets of tenants are satisfying my remainder rental mortgage and my home mortgage (PITI included). Talk about leveraging and the benefits of compounding!
My plan (hope) is to continue to dedicate my paycheck from my day job to maximizing my Simple IRA, paying cash for kids college so that they start life debt free, continue to invest and enjoy life. My wife is a teacher and we allocate a portion of her paycheck to covering utilities each month. She enjoys the remainder of her paycheck to do with, whatever she pleases. By the way, she is at 19+ years of a 30-32 year goal of Public Employee Retirement Account (PERA) Pension. I feel this is a great trade off and if it all goes by plan, we should be mortgage free with cashflowing properties, a nice pension, possibly some social security (at 62), and a SIMPLE IRA to really enjoy retirement in our 50s.
Sounds good to me! A 30-year fixed at 2.5% is very attractive. Hard to go wrong with that. And based on your track record of paying off your mortgages early, I have no doubt you won’t pay this one off before 30 years as well.
Paying off extra principal here and there is fun. It always feels good to pay down debt. I love just sending over an extra $500 – $3,000 here and there whenever cash flow or cash is high, or whenever I remember. These extra payments add up!
Super insightful thank you! Totally makes sense to go 15 year if one has the means and won’t lose out significantly on cash flow for investing.
I hear ya on the benefits of payment discipline of a 15 year vs a 30 year and paying it off sooner. Everything is easier when it’s automatic. I know I’ve had intentions of paying down extra principal and not doing it as often as I planned and not being able to keep paying extra consistently enough because of various distractions and being busy with other stuff.
Great insights and topic. Thanks Sam!
We got a 15-year note when we purchased our first home in 1999. If we stayed there, it would have been paid off already. That’s the nice thing about the 15-year FRM.
You’re right about a 30-year mortgage. You can make extra payments, but very few people can keep it up.
One of my personal guardrails is to not borrow with a term that would surpass my target retirement age. Ok to open a 30-year when you’re young, even if just to get you into the housing market. As you age and build equity, I see a lot of people making the mistake of taking out another 30-year to move way up in house.
I would not anticipate having the means or discipline of paying off a mortgage early.
I know lot’s of retirement guru’s talk about being debt free going into retirement but I tend to think that appropriate debt is not an issue. I will retire soon with a small mortgage at 2.6%. I plan to own the home another 3-4 yrs and see no issue carrying that debt into retirement. Assuming even small appreciation, there is some leverage at work. We can easily carry the payment and should the shit really hit the fan, we can pull funds to pay it off as there is plenty.
To me, it is just an asset allocation decision. In general, I expect to make more than 2.6% on my money. Paying off the affordable debt seems like a money losing proposition.
I get the math, especially at these rates. The differentiator for me is the type of benefits on this side of the coin:
Keep Mortgage – Higher potential returns with other investments, interest tax deduction (maybe), secured debt is a hedge against inflation.
No Mortgage – No interest payments, less income required to live/less income tax paid, more total stability in down market.
I guess if you have a paid off primary house and hold a mortgage on a rental property, this could be best of both worlds?
So when I refinanced our place and put money in from the old place a funny thing happened. My 300K loan was too little compared to the house value to qualify for a significantly better rate at a 15 year ona fixed interest rate.
The payment amount was so different cash flow wise I took the “best payment” and am putting into the market, savings, retirement etc. again. It also made a 6mo plan way easier and I turned out to be covid layoff resilient.
I’m still sore about not having a 15 year on my primary residence/long term place. It’d be nice to not have a mortgage when the kiddos are college aged and I would have cash flow and some various savings to help them with.
Great article. Currently considering to re-finance our 30 year loan now. I’ve done a few of them, so have 25 years left. After consideration, now thinking either 25 year or 20 year. Or just pay more per month and can try to get there without the refi. of course i have a higher percentage currently (3.25 not too shabby) but can get around 2.75 or lower if i refinance. Thoughts on this? Im not moving and plan on staying for a long time. The reason why i wouldnt do it so more for flexiblty, and ability to use money to build savings.
One loan infrequently mentioned is a 20 year fixed. You cut off 10 years of payments and the monthly payment is more digestible than 15 year. It’s also a lower rate than the 30.
I refinanced to a 20 year fixed late last year and got 2.375%. We didn’t feel comfortable with the size of the payment on the 15 year and the 20 year worked great. Not every lender offers a 20 year, but in my mind, it’s the best of both worlds.
Agreed. Our situation is similar.
I’m sure there’s good reason for it, but why don’t banks offer custom-term mortgages? I’m in the market for an 18.5 year fixed…
Agreed. The 20 yr seemed to make more sense when we bought, although the rate was 3.5% – pretty good, ten years ago. The only issue is that when I did refi, the natural new period was ten years which falls into some weird category that doesn’t have a much lower rate than a 15 yr.
It’ll be paid off in less than five years, because my wife distrusts debt over the long haul given life can change so much.
Love the idea of custom time frames, like 3500 days or a single Saros cycle (18.029 years). Time your purchase and pay off dates with solar eclipses…
Who will be the first to offer a loan less than 12 parsecs?
I also refi from 3.75% 30 yr to 2.5% 20 year last year. It was a good decision. I had 27 years left on the 30 year at the time and my new payment is equivalent to the 30 year loan.
Great article. This balances the dynamics of home ownership, wealth creation, asset allocation, and cash flow. And overall personal or family goals. For me, I’m in the middle of a path from 30 Year to 15 Year to All Cash.
1) First house purchased with 30 Year Mortgage – ~3x annual salary (not including bonus, stock, etc.). Allowed me and my wife to buy our first home as a married couple, with enough space to raise up to 2 kids.
2) Refinanced to 15 Year Mortgage last year.
3) Goal to have house paid off in <10 years.
End goal for our primary house is own it outright in our 40s. If we ever move or update, pay all cash. This allows us to explore owning a vacation home, or using the same budgeted money towards private school and education for our kids. Once your house is paid off you start to have real financial control of your life.
Mentally, the change to the 15 Year (and higher monthly payment) helped focus our wealth goals and stay disciplined in our savings and how we spend our money.
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It looks like a 15 year mortgage can save a lot of interest. The third disadvantage you mentioned (opportunity cost) is the only thing I’m concerned about. With inflation over 3% today, and a 5/1 year ARM at 2.64%, it’s almost like you could be paid to hold a mortgage, after accounting for inflation. But then again, inflation could very well drop lower next year and stay below 2% again. The lower interest rate of the 15 year fixed rate mortgage certainly gives you more piece of mind. :)
We bought a new primary residence in 2010 pretty near the bottom of the market of the great recession. Qualified and used the Federal home buyers credit offered at that time. Purchased with a 30yr, refinanced a couple of years later also into a 30Yr to lower payments.
In 2020 we had a comical 6 month, 3 application (w/ same company) re-fi. After the 8 years in the existing 30 yr loan we were able to make the switch to a 15Yr 2.5% mortgage for a net payment increase of $140!
In addition to the 7 years shaved off the loan period, our Principle portion of the payment doubled. We consider principle paid a direct addition to Net Worth so we appreciate the new 15yr very much.
Can’t you just take out a 30-year and then make extra payments? Seems to be more flexible than locking in the higher monthly payment on a 15-year.
Sure, that’s what many people who take out a 30-year mortgage do. But it’s often hard to follow through.
Further, the average rate on a 15-year mortgage is much lower than a 30-year mortgage. Therefore, you end up paying more interest if paid off at the same time.
That is exactly what we did and what we recommend to others getting started. Keep the mandatory payment low with the 30yr, and pre-pay. It gives one more flexibility as many people struggle to QUALIFY for even the 30yr.
Agree with Sam; paying extra is hard to keep up with if you don’t make it automatic. However, this is the path we took as it allows us to be more flexible with our money on a month to month basis.
In normal months, we pay extra against our 30 year to make it more like a 15 year. But, if there is a dip in the markets or some other bargain to be made on the investment front, we can just pay the minimum on the 30 year and invest what would have been extra principal.
We took a ten year loan out on our house when we refinanced while doing a big expansion of the home. Of course houses here are inexpensive with our four bedroom four bathroom house only representing about one year of our single income family’s pay, if that much.
My 5/1 ARM dropped to 2.75 from 3 in February, so I’m happy with that. And I have the cash if real estate drops (I know you said unlikely previously) and I get a house back in Florida since I regret selling mine 5 years ago when my job forced me to move to Pennsylvania (and now kids are well integrated into their great Pennsylvania schools and activities).