Mr. S. Lucero, a client, age 47, from Mesa, AZ writes...
"Mark, I would love your perspective on a 15-year vs. 30-year mortgage. Remember, my end goal is to retire at 62 and (1) if I take the 15-year, I'll pay my home off at retirement, BUT I fear I may be leaving money on the table. Or (2) I take the 30-year, invest the difference and, hopefully, beat the mortgage rate and use the extra cash to pay off the mortgage balance in the same 15 years. What are your thoughts?"
My friend, that is a GREAT question... and the answer requires some basic assumptions and a bit of number-crunching... so, let's get started...
I know that interest rates have gone up and I'm not sure how much you're looking to spend on a house, but that's not really relevant for now. I'm going to assume that you're borrowing $350,000 and that the monthly payment on a 30-year mortgage at 3.75% is $1,621, versus $2,417 per month on a 15-year mortgage at 3.00%. So, the difference between these two payments is about $800. That's the amount you'll save every month by choosing the 30-year mortgage.
I now turn on my financial calculator and enter $800 as the monthly savings, 5.00% as a very reasonable rate-of-return, and 360 months as the duration of the mortgage.
Result: Saving $800 per month for 30 years at 5.00% will give you $668,581.
(After 15 years, saving $800 per month at 5% will grow to $214,722. Should you apply that to paying off your mortgage balance? That will be the subject of a future newsletter!)
Next: For the sake of comparison, we'll calculate the highly improbable likelihood that someone who takes a 15-year mortgage... and saves ZERO for 15 years... suddenly develops the discipline to save $2,417 per month for the next 15 years!
So, $2,417 per month, at the same conservative 5.00% rate-of-return, for a duration of 180 months (15 years) will give you $648,729... about $20K less.
And because the two numbers are very close, what does this tell us?
First and foremost, there is very little difference between the two strategies: Saving $800 per month for 30 years or attempting to save $2,417 per month for 15 years. And, if there is very little difference in the results... which option is better?
Conclusion: The 30-year mortgage, in my opinion, is better for several reasons:
1. First of all, you're going to end up with more money. Remember, the example above was based on just 5.00% growth. With a higher rate-of-return, the "spread" increases. For example, at 7.00%, the spread grows from $20,000 to over $200,000!
2. Don't forget that the 30-year mortgage generates more tax savings via the mortgage interest deductions.
3. The lower monthly payments provide you with more liquidity for the first 15 years. That enables you to take advantage of investment opportunities, handle emergencies, avoid the risk of going into debt... and maybe even losing your house!
4. And, let's face it, the odds are much more favorable for a person to consistently save $800 per month than having the discipline to save $2,417 per month for 15 years, right?
Finally, let me be perfectly clear. You should never ever, ever invest your savings in a financial vehicle that could potentially lose money. With a mortgage on your home, that could be disastrous. The chance of losing your home to foreclosure and the damage inflicted on your family far outweighs any potential monetary benefit.
Not to worry. Fortunately, there are financial vehicles that offer tremendous upside potential with ironclad guarantees on both principal and growth... so there's absolutely never a need to gamble with your money!
Speaking of which... keep you eyeballs glued to your inbox. Within the next couple of days, I will be announcing "The Mother-of-All Bonuses!"
Not a joke.