Personal Finance Essentials

Selecting the Right Mortgage

Selecting the Right Mortgage:

15-Year vs. 30-Year and Beyond

RightMortgage

30-Year vs. 15-Year Mortgage: A Fair Comparison

Many people choose a 15-year mortgage to pay less interest overall. But comparison charts typically show thirty years of interest on the 30-year loan versus only fifteen years on the 15-year loan. That is not a fair comparison. Here is what a fair comparison looks like on a $150,000 loan at 7%:

Over the first fifteen years — the same period for both loans — the 15-year loan costs $242,684 in total payments, with only 38% going toward interest (the rest is principal, which is not tax-deductible). After the tax benefit, your actual cost is $219,513.

The 30-year loan over that same first fifteen years costs $179,632, with 78% going toward interest (highly tax-deductible). After the tax benefit, your actual cost is $144,467. The 30-year loan costs $75,046 less over the same period. The monthly payment difference is about $417 — money that, if invested at 10% annual return over fifteen years, would grow to $172,802. After fifteen years, the remaining balance on the 30-year loan is about $111,028. You could pay it off and still have over $60,000 left over.

The 15-year mortgage forces you to make higher payments, gives you smaller tax deductions, reduces your liquidity, and costs you tens of thousands in missed investment opportunity.


Fixed-Rate Mortgages

Fixed-rate mortgages are the most common type of home loan. The interest rate never changes, and the monthly payment never changes. Most come in 15-year or 30-year terms. They are considered the safest option because of their predictability, though the 30-year term produces the better wealth-building outcome for most borrowers.

Adjustable-Rate Mortgages

Adjustable-rate mortgages begin at a lower interest rate than fixed-rate mortgages, but the rate adjusts annually after an initial fixed period. Typical caps allow the rate to rise up to 2% per year, with a maximum lifetime increase of 6%. Always evaluate any mortgage under the worst-case scenario — not under the initial, attractive terms. If you would not be able to afford the payment at the maximum possible rate, do not take an adjustable loan.

How Amortization Works

Mortgage payments are structured so that in the early years, the vast majority of each payment is interest. In later years, the balance shifts toward principal. For a 30-year loan, the first twenty or so years are primarily interest payments, which are tax-deductible. This is one of the reasons a long mortgage has substantial tax advantages: you are maximizing the deductible portion of your payment for most of the loan’s life. The lender collects its profit (interest) first and returns the borrowed principal later. This is also why refinancing an old loan that is mostly principal payments restores the tax benefit — you restart the amortization schedule from the beginning.