Have you heard the financial pundits tell you that you need to do a 15-year fixed one? They tell you to do this to save you tens of thousands of dollars in interest payments as compared to a fixed 30-year mortgage. And the trust is that they can save you a substantial sum of money. But what does that save money cost you? In this post, we will look at the total cost of a 15-year fixed mortgage.
First, we will layout the assumptions of this example. We are using the rates for the two mortgages taken from www.bankrate.com on September 29, 2020. The interest rate for a 15-year fixed new purchase mortgage was 2.54%, and the 30-year fixed new purchase mortgage was 3.07%. There is roughly a 0.5% difference in the two mortgages, which is closer than it may have been in the past, but we are looking at current and not historical differences. The house we will purchase is $400,000 with $80,000 down to avoid Private Mortgage Insurance resulting in us financing $320,000. Now for the differences.
The 15-year mortgage requires you to pay a monthly payment of $2,135.24 for a total cost of $384,342.59. That means this mortgage costs you approximately $64,000 in interest. The 30-year mortgage will have a payment of $1,357.77 and a total payment of $488,797.25, costing you approximately $169,000 in interest payments. The actual savings between a 15-year and 30-year mortgage is $104,454.66, which is not an insignificant amount to consider.
But let us look at what that $104,000 in savings could cost us in terms of investments. For this part, we will assume that you invest in something similar to a low-cost indexed fund, such as the S&P 500. And here, we will use a conservative estimate of getting an annual 9% return on our investment. So, what are we investing, you may ask? In the case of the 15-year mortgage for years 1-15, you save nothing. Then in the years 16-30, you will save your former monthly house payment of $2,135.24. The 15-year mortgage will result in a portfolio value of $814,045.74 after the 30 years. In the case of the 30-year mortgage, you will save the difference between the two of $777.47 for the entire 30-year period resulting in a portfolio value of $1,434,016.71.
There is a significant difference between these two amounts and how they were arrived at on the face of things. The 30-year mortgage will end with a massive difference of $619,970.97 in your favor. But wait a minute, the 15-year mortgage did save you $104,454.66 in interest payments, so we really should consider that in this as well. So, we will back the interest savings out of the difference, and the approach taken for the 30-year mortgage results in an extra $515,516.30 in your portfolio account.
Yes, a 15-year mortgage will save you approximately $104,000 in interest payments, but it could ultimately cost you $515,000 in lost investment income. This is why I am not a big fan of the 15-year mortgage than a 30-year mortgage. For this to work, you must have a fixed-rate mortgage and be dedicated to saving the difference every month like you would in any well-designed financial plan and investment strategy.
While everyone has different financial situations, which may or may not be a workable solution for you, it should be considered when taking out a mortgage. What appears to be saving you money may cost you hundreds of thousands in lost opportunity costs, as demonstrated here.
If you need more assistance or have questions, please contact me or reach out to any fee-only Registered Financial Consultant.
