More than 5 million homes get sold in the country each year. Assuming 80% of them are financed through a mortgage – 4 million households face the question ’30 year vs 15 year mortgage’ every year (and in my opinion 90% – 3.6 Million – do not understand all the differences):
How to compare 30 year vs 15 year mortgage?
First off – there is no straight forward answer to the decision between 30 year mortgage vs 15 year mortgage, here is a screenshot of an Excel spreadsheet that I developed to make my decision:
30 year vs 15 year mortgage
What are the factors that go into that decision?
1. Mortgage interest rate – 30 year as well as 15 year
2. Your ability to pay higher monthly mortgage payments in 15 year scenario (My Excel does not cover it but something to keep in mind)
3. Return on investments – market return – this is the rate of return you expect to earn on your investments (idea being – mortgage payments are low in 30 year scenario, you will invest the balance in assets that will produce returns). This is cell M2 in my Excel. I used 8%, you can change it to whatever you like
4. Tax break – this is the tax deduction you get on mortgage interest payments. Right now the Excel shows 35%, you can change it (Cell U2).
5. Finally – the capital gains tax rate (Cell U3). I took 23.8% – 20% capital gains tax rate and 3.8% NII tax – net investment income tax.
Spreadsheet Columns, starting at Row 9
A – E: Refer to 30 year mortgage scenario
30 year vs 15 year mortgage _ 30 year columns
Column A – period (1 = 1st month, 180 = completion of 15 years, 360 = 30 years)
Column B – Monthly mortgage payment
Column C – Interest part of the monthly mortgage payment
Column D – Principal part of the monthly mortgage payment
Column E – Outstanding principal (money you still owe to the lender)
G – J: Refer to 15 year mortgage scenario
G – J are for 15 year scenario what B – E were for 30 year scenario
L – P: Compare 30 yr plan vs 15 year plan
30 year vs 15 year mortgage _ Comparison
Column L – difference in mortgage payments = cash in hand
Column M – Monthly return on investment (cash in hand multiplied by monthly return expected)
Column N – Cumulative portfolio value (every month there will be additional cash in hand that will be invested to generate the monthly market returns)
Column O – Monthly mortgage is less on 30 year but the principal outstanding is more. This is the Extra Principal owed (on 30-yr plan)
Column P – How much better is 30 year plan?
R – X: Tax savings on 30yr plan
This section talks about the extra mortgage interest paid on 30 year plan, tax savings due to mortgage interest deduction, cumulative tax savings over a period of time, market returns on the cumulative tax savings, and the portfolio value of the end result (tax savings + market returns on these tax savings).
30 year vs 15 year mortgage _ Tax considerations
Columns Z – AA:
Z calculations show how much better is 30 yr plan over 15 year (negative value shows how much worse 30 yr plan is vs 15 year). Column AA is just the PV (present value) of Column A.
Also – the answer depends on the time you will end up staying in the house, this chart here shows how much better / worse 30 year mortgage is as compared to the 15 year mortgage (x-axis is the time spent in the house).
As you will notice – till about 96 months (about 12 years), 15 years was better…. but after that 30 year turned out to be better….. peaking at about 210 months (17.5 years)… and then again coming back close to 0 at the end of 30 years.
Please also note – this is for 8% market return, 35% tax break on interest (ignoring the mortgage interest phaseout that starts to happen at $166,800 AGI).
1. This analysis assumes that you are a disciplined financial investor – if you suspect that you will end up spending the money (rather than investing) if your mortgage payments are less, then forget this whole mumbo jumbo – just take the ‘shortest duration’ mortgage that you can afford to pay and pay it off in the quickest possible manner.
2. One thing I have not included here specifically are ‘state taxes’. They also should be included for a complete picture.
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