Money Maven: 15- vs. 30- year mortgages

By Sheryl Rowling

SAN DIEGO — Dear Money Maven:

Q:        My wife and I are buying our first house. It’s a bit of a financial stretch for us, so we’d like to get the lowest interest rate possible. We’re borrowing $300,000 and have a choice between a 30-year fixed mortgage at 4% or a 15-year fixed mortgage at 3.5%. Should we choose the 15-year mortgage?

A:        I would advise against it. The 15-year mortgage will actually result in higher monthly payments than the 30-year mortgage because you will pay down the principal over a shorter period of time. It might seem like a worthy goal to pay off your mortgage in 15 years, but locking yourself in may not be a good idea. Why? Although you may choose to pay more than the required payment on the 30-year loan, you do not have a choice to pay less than the required payment on the 15-year loan. If this purchase is a “stretch” for you, you’re better off not risking your credit (or foreclosure) if the higher payments turn out to be more than you can handle.

Q:        My husband and I are buying a new house. We think we can handle the new loan payments, especially since we’ll get a good tax deduction for the interest. Still, we don’t want to pay out a lot of interest over the life of the loan. We’re borrowing $300,000 and have a choice between a 30-year fixed mortgage at 4% or a 15-year fixed mortgage at 3.5%. Should we choose the 15-year mortgage?

A:        Maybe not. Since you only “think” you can handle the new loan payments, you might not want to lock yourself into the higher 15-year payments. It’s true that the interest cost over the years adds up to a lot. Plus, after 15 years with the shorter mortgage, you can invest the money you’d normally be spending on your house payment. It seems like a “no-brainer” to take the shorter mortgage, right? Not necessarily. First, do you really think you’re going to live in this house forever? Second, you get a tax deduction for the interest paid. And, finally, with the 30-year mortgage, you can invest the lower monthly payment (and the tax savings). As long as your after-tax investment return is greater than the after-tax cost of your mortgage, you will come out ahead with the 30-year loan.

Q:        I’m buying a new house and know I can afford the payments. I wish I would save some money every month, but I tend to spend whatever free money I have left over after paying my bills. I’m borrowing $300,000 and have a choice between a 30-year fixed mortgage at 4% or a 15-year fixed mortgage at 3.5%. Should I choose the 15-year mortgage?

A:        Probably yes. By paying the higher mortgage payments associated with the 15-year loan, you’ll have “forced savings.” The extra money will go to pay down principal and you’ll effectively be earning a 3.5% pre-tax return. That sure beats zero percent!

Q:        I’m not buying a new house. I’ve been paying on my 30-year mortgage for 15 years. While I was working, my tax bracket was 35%. Now, I’m retiring and my tax bracket is only 15%. I owe $200,000 on my 4% mortgage. I have plenty of savings earning interest at 3%. Should I pay off my mortgage from savings?

A:        Yes. At this point, your mortgage is costing you 3.4% on an after-tax basis. Your after-tax interest income is only 2.55%. Paying off your mortgage would be a good move.

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Sheryl Rowling is a certified public accountant, personal finance specialist, and principal of Rowling & Associates. She may be contacted via sheryl.rowling@sdjewishworld.com