If you can handle the payments on a 15-year mortgage, you'll save tens of thousands of dollars in interest and own your house free and clear in half the time it takes to pay off a 30-year mortgage. But is this the best use of your money?
Two professors who compared the two mortgages argue that for many people, the 30-year mortgage makes better sense. They say you're better off with the longer-term mortgage if:- You're in a high tax bracket.
- You buy an expensive house.
- You plan to keep it for a long time.
How can this be true?
- The higher your tax bracket, the greater the tax break you get for paying mortgage interest. And you pay a lot more interest on a 30-year mortgage than on a 15-year.
- The more expensive your house, the higher the monthly payments. And they're especially high on a 15-year mortgage. If you invest the extra money you would have to put into a 15 year mortgage in a tax-deferred stock account, you'll come out way ahead.
- This strategy works best with long-term investing.
The study, published in the April issue of the Journal of Financial Planning, argues that homeowners should make their mortgage part of an overall financial plan. "The purpose of this paper is to demonstrate that for investors with access to tax-deferred investment plans such as a 401 or a 403 the 30-year mortgage is clearly the best financial choice for many home buyers," Appalachian State Uni-versity professors Delbert Goff and Don Cox wrote.
The professors looked at a $150,000 mortgage for a borrower whose combined state and federal tax rate is 33 percent. The borrower has a choice between a 15-year mortgage at 7.5 percent and a 30-year loan at 8 percent.
- Choose the 15-year mortgage and after it is paid off, start investing your old mortgage payment in a tax-deferred account yielding 10 percent a year on average. At the end of 30 years (15 years of mortgage payments, 15 years of investments), you'll have $791,288 in your account.
- Choose the 30-year mortgage and invest the money you would otherwise be spending on the 15-year loan. After 30 years of mortgage payments and investments, you'll have $1,170,239 in your account, assuming a 10 percent annual return in a tax-deferred account.
The authors say the 30-year mortgage is better even if you plan to keep the house for a shorter time - say, six years.
But this plan is not for everyone. The authors note that for the plan to work, the homeowner must have the willpower to make those investments every month. And you must be willing to put the money into stocks or other investments that have a yield as high or higher than the 8 percent mortgage rate.
If you're scared of stocks and put all your money into savings accounts and certificates of de-pos-it, you're probably better off with a 15-year mortgage.
Additionally, the authors say the lower your tax bracket, the less expensive the house, the more attractive a 15-year mortgage.
"The benefits of the 30-year mortgage are greatest for home buyers in high-tax brackets buying relatively expensive homes," they say. "For this strategy to work to its fullest, the home buyer must have the ability to make the higher 15-year mortgage payments and have the will-power to invest the difference between the 15-year payment and the 30-year payment in a tax-deferred investment plan."