Pay off your 30 Year Mortgage in 15 Years

This is the age old debate. Do you get a 30 year fixed mortgage or a fixed 15 year fixed mortgage. 

15 year mortgage PROS:

• Lower Interest Rates

• Pay less interest over time 

30 year mortgage PROS:

• Lower monthly payment each month in comparison to a 15-year moved. 

15 year mortgage CONS:

• Higher monthly payment

30 year mortgage CONS:

• Higher interest rate

• Higher overall cost to own home after all payments are made in 30 years

My issue with a 15 year mortgage is that you are stuck with that higher payment, with few options to pay less. For this reason, I like the option of getting a 30 year fixed mortgage with no pre-payment penalty, and paying extra on your principal every month to reduce your overall payments. This option works because you lock in a low monthly payment. Therefore, in tough financial times, you are only required to pay the lower 30 year rate, and in good financial tiems, you can pay extra to reduce years on your loan. 

The average 15 year mortgage rate in 2021 is around 2.5% and the average 30 year mortgage rate is around 3.0%. 

Now of course, mortgage rates depend on:

• The bank you use, if they are running any specials or promotions, and what type of loan packages they offer

• Your credit score

• How much of a down payment you put down

• And other factors like this. 

3 Scenarios

So lets run some numbers to see your cost difference. 

Let's say you are buying a $250,000 home and putting down 20% ($50,000) giving you a loan/mortgage amount of $200,000. (In this scenario, we are assuming a 20% down payment because anything less than 20% accrues an extra monthly fee called Private Mortgage Insurance or PMI.) (Also keep in mind that the numbers below do not include your monthly escrowed expenses for Property Taxes and Home Insurance).

Scenario A: 15 year fixed mortgage at 2.5% paid off in 15 years

• Monthly Payments on Principal and Interest: $1334/month

• Total Paid after 15 years of loan payments: $240,045

Scenario B: 30 year fixed mortgage at 3% paid off in 30 years

• Monthly Payments on Principal and Interest: $840/month

• Total Paid after 30 years of loan payments: $303,555

Scenario C: 30 year fixed mortgage at 3% paid off in 15 years with no pre-payment penalty. 

• Monthly Payments on Principal and Interest: $840

• Extra paid on Principal Every month to pay off in 14 years: $541

• Total Paid after 15 years of loan payments: $248,610

(Other fees these examples don't include: loan origination charges, discount points paid, other settlement fees)

Analysis

• When comparing Scenario A and Scenario B:

  • Your 15-year loan will cost you $63,510 less in the total cost of the loan in comparison to paying your loan in 30 years at the 30 year fixed rate. 

  • You will be required to pay almost $500 more per month ($494 exactly) when you are locked into a 15-year loan. You do not have the option to pay less, because paying anything less than your minimum 15-year monthly mortgage payment of $1334/month may put you in default on your loan, and may lead to foreclosure. 

  • When you pay your 30 year fixed loan off in 30 years, you can save that ~$500 for anything that you want (childcare, transportation, other expenses, etc.)

• When looking at Scenario C:

  • You have the option to pay the additional $494 which is what a 15 year loan would cost you per month, on your mortgage every month. It still may take you slightly more than 15 years to pay off your loan, but you will be a lot closer than when you pay the minimum amount over 30 years.  

  • However, if you fall on tough times during that 30 year period, you can safely go back to paying $840 without having to worry about defaulting on your loan and possibly going into foreclosure.

  • In order to pay your 30 year loan off in 15 years, you will need to pay around $541 extra month with the additional payment going directly towards your principal payment). This works if you do not have a pre-payment penalty on your loan.

  • When you pay your 30 year loan in 15 year, you will still be paying it at a higher interest rate (3% vs. 2.5% in these scenarios). Therefore, the 30 year loan paid over 15 years will cost you $8,565 more than a simple 15 year mortgage over the life of the loan. While you may want to lock in the lower 2.5% interest rate, keep in mind that if you every need the additional $500, you won't be able to access it. So that $8,565 is really a small price to pay over 15 years, so you to be able to have access to an additional $500 during a rainy season. Think about it. $8,565 / 15 year = $571 a year or $47.60 a month. So essentially, by paying an extra $50 fee per month, you are guaranteeing yourself access to $500 a month, if you need it. 

  • Keep in mind, that for the time period that you don't pay the additional $500+ a month additional towards your principal, you will need to add that time back to the end of your loan, or double up payments at a later date if you are financially stable and/or have a financial surplus. 

  • With a 30 year fixed mortgage that has no pre-payment penalty, you are also not stuck to trying to pay off the loan in 15 years. You can choose to pay just enough additional principal to pay it off in 20 years, or 18 years. What if you want to give a rental property paid in full to your child on their 18th birthday. You can choose to get a 30 year fixed mortgage with no prepayment penalty and use the additional rents to make additional payments so that the house is paid off by their 18th birthday. In this case, in addition to paying the $840 a month towards the Principal and Interest, you will pay an additional $311 towards the principal. Or say, you want to wait for their 21 birthday; then you will only need to pay an additional $181 per month. 

  • A 30 year fixed mortgage with no pre-payment penalty gives you flexibility to pay more on your principal when you have the financial ability to, but not be stuck paying that higher additional amount during the rainy days, months, years. 

• Scenario B Options: The difference between a Property Owner vs. a Property Investor

  • Thinking outside the box: Also, lets think about that additional $500+ a month payment. Can you invest that additional $500+ a month into something that is going to make even more money. 

    • Since the 30 year loan will cost $63,510 more over the life of the loan, you have to ask yourself, in 30 years, what can I invest that additional $500 a month or $6,000 a year in that will give me $64,000+ in profits so that the cost of my 30 year loan would be worth it. 

      • For example, say you are able to save $500 a month for 2 years. Now you have $12,000 in your bank account. You have done your homework and met with a real estate investing coach, and found that you can purchase a new home for $150,000 with a 3.5% FHA down payment. This means your down payment will only be $5,250. This is perfect because you negotiated with the seller to cover all of your closing costs. The allows you to keep the additional $6,750 in the bank to show your bank that you have at least 3 months emergency savings in cash reserves. Now you can rent out your old home. Let's say your rent out your old home that you originally bought with $20% at $250,000 making your monthly mortgage payments $840. Your monthly expenses come in around $1200 which includes $840 towards your mortgage an additional $360 towards your Property Taxes and Home Owners Insurance. You do research and figure out that you an rent your old house out for $1500. If you subtract $100 a month to go towards repairs, that will make your monthly cash flow $1500 - $840 - $360 - $100 = $200 month.  That means each year you will make $2400 a year on your old property. If you repeat this process 2 more times, over the next 6 years, then you will have 3 rental properties making $2400 x 3 = $8,400 a year or $600 a month. (You should even cash flow a little more per month since your first home was bought for $250,000 and now you are buying $150,000 homes, which makes your monthly expenses even lower But let's keep the numbers as simple as possible). This $600 a month is more than the $500 a month you were initially saving, so now you can choose to put that extra $500+ a month towards principal payments on your mortgage to reduce the amount of years you have to pay your mortgage. Or you can put the full $1100 towards additional principal payments (either on 1 property, or split it among the different properties). When year 15 comes, now you have more options. Do you sell one of your rental properties and use the proceeds to pay down your principal on your primary residence. Do you sell all of the rentals? Do you keep 1 rental so that after 30 years, you have a primary residence and a rental property with no mortgage? (This would mean that at year 30 you have 2 houses paid off, with one of the houses bringing in $840 + $200 = $1,040 a month of rental income.) 

      • Or lets say you repeat the cycle for 15 years, buying 1 new property every 3 years. In 15 years, you will own your primary residence and 5 rental properties each cash flowing $200+ a month. So that's $200 x 5 = $1,000 a month. 

      • But what if you repeat the cycle for 30 years buying 1 new property every 3 years. In 30 years you will own you primary residence and 1- rental properties each cash flowing $200+ a month. SO that's $200 x 10 = $2,000 a month. Buy now the 1st home that you ever bought will be paid off in full. You can chose to move back into that house which now has no mortgage payment and rent out the most recent house you purchased. Then you are living in a home with no mortgage and receiving $2,000 a month. Plus every 3 years one of your rental properties will be paid off in full. So on year 33 you own 2 properties paid in full. On year 36, you own 3 properties paid in full, and so on and so forth. (Theoretically, once you no longer have a mortgage on those properties, you will be able to use more of the rent to add to your monthly cash flow. But realistically, after 30 years, the property will need more repairs than when you first bought it, so you can use the portion of the rent that would have been for the old mortgage to go into a repair fund. If you are smart, you can try to sell that property at market value, and use the proceeds to do a 1031 exchange into a similar rental property that is newer and has less repairs.).

      • There are so many different options you have. But the most important takeaway, is that the way you use that additional $500 a month can have a huge impact on your financial future.  

Resources

• Bankrate.com Loan Calculator: https://www.bankrate.com/calculators/managing-debt/annual-percentage-rate-calculator.aspx