Last week, I announced that Kris and I have refinanced our mortgage at 4.96% for 30 years. In the comments, Ian expressed disappointment that we’d opted for the longer term when we could have afforded to take out a 15 year mortgage at 4.625%. “Starting your 30 years over is no way to get rich slowly,” he wrote.

He has a point.

Kris and I took out the 30-year mortgage because we wanted a safety net. We will continue to pay $2,000 each month toward our mortgage, so we *could* have afforded the shorter term, but we opted to take a longer mortgage so that we had a cushion if something happened.

But was this a smart move? How much will it cost us to do this? Let’s find out.

**Running the numbers**

You all know that I love to play with spreadsheets. I pieced one together to run the numbers on our mortgage. Just for curiosity’s sake, I first looked at what might have happened if we had not refinanced at all and planned to repay the old loan on a normal schedule (you can play with actual mortgage rates get current numbers):

*Existing mortgage pre-refinance*Principal remaining: $206,345.33

Interest rate: 6.25%

Total payments remaining: 303 (25 years, 3 months)

Regular payment amount: $1386.60

Total repaid: $420,139.80

Total interest paid:

**$213,794.47**

Interest/Principal: 103.61%

Now, here are the totals if we were to pay the refinanced, 30-year mortgage without any sort of acceleration. Note that the payment amount does *not* include taxes and insurance (which adds another $280.21 to our monthly obligation).

*30-year without acceleration*Principal borrowed: $212,900

Interest rate: 4.96%

Total payments: 360 (30 years)

Regular payment amount: $1137.69

Total repaid: $409,568.40

Total interest paid:

**$196,668.40**

Interest/Principal: 92.38%

By refinancing, we’re saving $10,571.40, even if we don’t pay extra, and even if we stretch the loan out to 30 years. Next, I looked at a 15-year mortgage without any sort of acceleration.

*15-year without acceleration*Principal borrowed: $212,900

Interest rate: 4.625%

Total payments: 180 (15 years)

Regular payment amount: $1642.30

Total repaid: $295,614.00

Total interest paid:

**$82,714.00**

Interest/Principal: 38.85%

Clearly, a 15-year mortgage is a better option — *if* you can afford to make the payments, which in this case would cost an extra $504.61 every month. (And if inflation isn’t running rampant. I have not accounted for inflation in any of these scenarios.)

But Kris and I pay more than the minimum. We pay a flat $2,000. If we subtract $280.21 for taxes and insurance, that means we’ll be paying $1719.79 toward principal and interest each month. How does this affect our costs? Let’s look at the 30-year loan with accelerated payments:

*30-year with acceleration*Principal borrowed: $212,900

Interest rate: 4.96%

Total payments: 174 (14 years, 6 months)

Regular payment amount: $1719.79 ($1327.97 final month)

Total repaid: $298,851.64

Total interest paid:

**$85,951.64**

Interest/Principal: 40.37%

**This is the plan we intend to follow.** For us, there is a huge difference in the total we pay (and how long it takes us to pay it) between an accelerated and a non-accelerated 30-year mortgage. We save over $110,000 and 15 years by making extra payments.

But we will still pay more interest than if we had taken the 15-year mortgage. What about accelerating the 15-year mortgage? Let’s look:

*15-year with acceleration*Principal borrowed: $212,900

Interest rate: 4.625%

Total payments: 169 (14 years, 1 month)

Regular payment amount: $1719.79 ($960.31 final month)

Total repaid: $289,885.03

Total interest paid:

**$76,985.03**

Interest/Principal: 36.16%

Financially, this is the best option of all. But it only shaves 11 months and about $6,000 from the standard 15-year option. Ian may be right: it might have made more sense for us to take a 15-year loan.

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**Doing what works for us**

Let’s assume that Kris and I are going to be able to make our $2,000 payments every month for the next 15 (or so years). If we had opted for the lower-rate 15-year loan instead of accelerating the 30-year loan, we would have the debt paid off five months earlier. What’s more, we would save $8,966.61 in interest payments, or roughly $640 per year ($53 per month).

Ian’s point — and it’s a good one — is that although Kris and I saved $250 per month by refinancing, we could have saved *another* $50 per month (with no changes to our current plans!) by choosing a 15-year mortgage instead of a 30-year mortgage.

Did we make the wrong decision? Time will tell. If nothing happens along the way, then this will have been a poor choice. But if we experience some sort of financial setback, our caution just might save our bacon. **With the lower payments of the 30-year option, we could live indefinitely on either one of our salaries alone.** As with all investments, lower risk brings lower reward — and that’s the choice we made this time.

**What choice would you have made and why?** I suspect that many GRS readers opt for 30-year mortgages when they could afford the higher payments and the shorter term. I know that we’re certainly not the only ones among our friends who have done this!

**Note:** I did not save the spreadsheet that I used to run these numbers. If you’re wanting to do similar math, check out the mortgage calculators at Dinktown.

GRS is committed to helping our readers save and achieve their financial goals. Savings interest rates may be low, but that is all the more reason to shop for the best rate. Find the highest savings interest rates and CD rates from Synchrony Bank, Ally Bank, GE Capital Bank, and more.

This article is about House & Home, Budgeting, Choices, House and Home

I used to be a mortgage broker, and without exception, the majority of my clients chose a 30-year fixed mortgage over all others. The biggest reason — affordability. I myself refinanced into a 15 year mortgage, but the problem with it is you always have that high monthly payment. I came back to a 30 year fixed because I can always pay more when I have the money. You don’t have an option to pay less on a 15 year fixed.

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What about MIP? With a 15 year you can forgo the MIP, which is a significant percentage of the escrow if only you pay 10% down. Where as that is not an option with a 30 year. Also the Upfront MIP is tax deductible giving you a little more cushion just after you buy the property. I have never seen a calculation that takes this into account. Have you?

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For me it wasn’t a matter of could I afford a 15 year mortgage, it was more like “Can I afford a 15 year mortgage while building 6mos emergency funds, maximizing my employer 401K match-ups, remodeling, and having a life.

The answer was “No.” I know some people would say “then that means you couldn’t afford it.” However, a lot of the financial decisions and goals I make are born out of what I have left to work with. I consider the extra confidence I have to take out 6% for retirement (plus 1k/year towards my ROTH IRA)to pay me back 10-fold any interest discrepencies (sp?) Also 15 years is a long time. I’m currently single w/no kids and have no idea what the future holds.

I’m young and still making choices for my financial, education, and career future and the last thing I need is to lock my money into a mandatory (albeit affordable) loan. What if I wanted to use extra money to become certified in something or go back to school that will allow me to make more money? Personally, I feel that 15 year mortgages are for those who are pretty much financially settled and have done most of the things with their money that they wanted to do and who’s main financial goals for the future are paying off their mortgage.

Right now in my life I have my financial sights set just a little above paying off my mortgage. Ideally I would like to save my money in a moneymarket or high yields savings to CD until I can pay off my mortgage in 10 years or so, but if I decide I want to use some of that money to upgrade my house or life I would be ok with that and I want to always have that option.

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Mike, data suggests a long term average 10% market return. We had a wild 80′s and 90′s and lousy ’00s so far. From where we are right now, I don’t know that 7.5% isn’t right on target. It’s likely pretty conservative. On the other hand, between my low rate and current high tax bracket, my break even return needed is about 4.1% over the next 15 years or so.

Is it guaranteed? Of course not. But the banks are far from rich and I am far from a slave. Why the hyperbole, when RC was offering reason?

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@RC #115

7.5%? Since we’re making up numbers, I’ll pick 14%

Where will you find a guaranteed 7.5% return for the next 20 years? Kudos to you if you’re on the inside track and know of something we don’t. For the rest of us on Earth, stock market returns are not guaranteed.

What is guaranteed is the more interest you pay the bank, the richer you make them and the longer you’re their slave paying back the debt.

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I have it on anecdotal authority from a banker I know very well that not only is refinancing HUGE right now, but also his bank is seeing at least a 300% jump in prepayments to mortgages. Lots of folks, in other words, are refinancing and putting extra money towards the principal. For once, here’s a national financial trend concerning mortgages that shows Americans can be prudent! Wonder if this is the beginning of a new psychology…

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We had 24 years left on a 30 at 6.5%. Just re-fi’d down to a 15 at 4.5%. This is a total no brainer for us. Our payments only went up $120. We should still pay of the home by the time I’m 40 (8 more years!)

Granted we are in a small home, but I don’t ever want to have a 30 yr. again. It is the same to me as having debt. With the 15 year, as long as I make the payment, I’ll be guaranteed the 15 year payoff.

If the rates drop to 3.5% I’ll refi again. maybe to a 7.5 year loan if they’d give it to me!

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Interesting. My wife and I opted for a 30 year fixed, bi-monthly mortgage. We’re living on a single income while our kids are young, and we plan on refinancing to a 15 year once we’re up to two incomes again. I figure this way we will have really only paid under 20 years!

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#116JOETAXPAYER:

I will say that if it was this time 2yrs ago I would have went with the prepayment method to pay it off earlier. But with the market being this low I feel you are better off investing your money instead of prepaying your mtg. We will be locking in tomorrow at what looks like 4.5% with 1/2pt. I would like to hold out for something lower but after seeing the rise today in the market and watching the rates go up and down like a yo-yo, I don’t want to miss out on this rate. Yes it may go down and I already spoke with the bank rep who stated that if it did fall to 4% they would make an adjustment to my rate to come down on it. I just like the fact that I will have the liquidity in my control and the option to build a nice nest egg above and beyond my retirement pkg I have.

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I agree that you are making the right decision. Looking forward, will the market return 4% (the LT cap gain someone in the 25% bracket needs to break even to 4.5%)? From this point I’d say yes. In hindsight, 10 years ago, this strategy didn’t work, the market is where it was in Q2 of ’97. There are periods of time where prepaying makes sense, but usually it doesn’t. It’s people’s fear of getting caught in that bad period that keeps them from doing what makes good sense 90% of the time. Consider – given the Trillion Dollars the treasury is now printing, inflation is coming back with a vengeance. When it does, you’ll be buying 8% tbills, when others will simply have their mortgage paid off.

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I must say finding this site was beautiful. My wife and I are looking at refinancing our current 30yr @ 5.875% to a 30yr @ 4.5%. After reading all the posts it made my decision easy as going with the 30yr @ 4.5% will lower my payment by $450.00, and like the others posted we are doing it for flexability. We are in our VERY late 30′s and are only 4 1/2 yrs into our mortgage.

I must ask why so many people are making prepayments vs pumping the money into the stock market or mutual funds. If you use one of the many investment calculators you will see that this can help you in a few ways.

1) at 7.5% $450 a month will give you $250k in 20yrs.

2) you have enough to pay the mortgage off at 20yrs along with about an extra 100k left over.

and if you really want to leave that money in for an additional 10yrs (30yrs total) you will end up with 610k.

Just my .02

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My wife and I just pulled the trigger today. Got 4.75 on a 30 year mortgage. We went with the same reasoning J.D. had. We could easily afford the payments on a 15 year mortgage but we are still very nervous about the economy and really want to have the flexibility. We aren’t particularly worried about our own jobs but we are concerned about having to help out our kids during an extended downturn since one of them is married to someone in the construction field and another is going to graduate from college in a year and a half.

I just wanted to thank not only JD but all the commenters. It’s a pleasure to go on a website and see so many well informed people respectfully and cogently taking different sides on an issue.

Thanks to all of you.

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XW – your number 3 is dead on. You don’t mention a rate, but I imagine the 30 would be 4.75% or a bit less. It’s not tough to imagine rates going well above that as we come out of this cycle. The idea of investing risk free at a rate higher than you pay on your mortgage is a beautiful thing.

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I think you made a very good decision. I am refinancing my 20 year fixed to a 30 year fixed.

There is 3 reasons for that:

1. now the 20 year rate is higher than 30 year, and the 30 year rate is not significantly higher than the 15 year rate.

2. Safety cushion. I will only take the rate of 30 year fixed, but still pay additional to make it work on that 20 year schedule.

3. I expect the inflation in the next few years, may not be in next 1 or 2 years though, but it will come. If the inflation rate gets really high and make the saving rates at bank higher than the mortgage rate, I can put the the extra cash into CDs instead of paying into mortgage, thus, I can get ahead of paying off the whole thing and be debt free.

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@rachel

I must respectfully disagree. Every month I pay a substantial amount to “principal only” on a 30 year fixed and the interest is re-computed (ie, less than it would have been) for the next month. If that wasn’t the case, then there’d be practically no reason to pre-pay.

The only way I can see it not changing is if the bank is mis-applying your payment to the next month’s payment instead of principal only. This is called an “acceleration of payment”, not a “prepayment of principal”. I worked in a bank years ago, and I saw the bank do that regularly (much to the ire of the customers). However with my current lender, I pay online and the form specifically allows me to apply extra to principal.

Heck, I threw an extra $5K on the mortgage a few months back and knocked almost $50 off my interest payment beginning the very next month. It’s tangible. And no, my payment due didn’t go down, but the portion of the payment that went to interest certainly did.

I guess the lesson is that if you decide to pre-pay, make darned sure that you don’t have a pre-payment penalty clause in the loan document, and also follow up to make sure the lender is applying the extra to principal and not just moving up your next payment.

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A lot of people forget that personal finance decisions are made for, well, personal reasons that sometimes transcend the absolute bottom line.

In the end, you did the right thing for you, JD. That is what is important. Not whether you could have saved an extra few thousand bucks over a long period of time.

As I detailed on my blog a while back, I refinanced from a 20 year loan back to a 30 year loan to give me the maximum flexibility in case I lost my job. As long as I stay employed, I will continue to accelerate my payments so that my mortgage is still paid off within the next 10 years.

BUT if I lose my job, I will be able to make my new $632 mortgage payment with no problem for years.

Flexibility is the key.

With that crazy-low mortgage payment I have no trouble sleeping at night despite the rotten economy. And if I manage to stay employed, my house is still paid off early!

Len

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Rachel, your first paragraph is simply incorrect. If you look at an amortization schedule, you can see the original plan. But, as soon as you make any prepayment of additional principal, the interest charged changes compared to that schedule.

One way to look at it is that you can look at that schedule and pay the exact amount of principal that would be due next month. For that small prepayment, you skip ahead a full month on the schedule. On my site I offer a spreadsheet free for the downloading, primarily to debunk the “money Merge Account” scam, but it’s an amortization schedule for those who like spreadsheets.

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RP -

I stand by what I wrote. Fixed loans like mortgages have a predermined amount of interest per month that has been calculated on the ORIGINAL LOAN AMOUNT, not the current outstanding principle. The amount of interest due will go down each month, according to the predetermined schedule.

I’m really puzzled by your reasoning. The fact that you have made pre-payments of various amounts and yet the interest/principle split on your loan still matches the amortization spreadsheet only proves the point that this is all predetermined.

If you have paid a lot of extra money on your mortgage, it might be worth your while to refinance just to re-set your interest using the new lower principle balance. An online mortgage calculator can show you if it’s worth it, not counting fees associated with refinancing. In any case, I know it was for me!

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My husband and I refinanced a couple of months ago. We could have gone with a 15 year mortgage, which would have upped our monthly payment by about $500 (if I remember correctly). I talked my husband out of it. Here’s the reason, while we could have afforded the payment, we would have been stretching it. I would have had to watch every single penny spent. Right now the mortgge is the only debt we have and we put a lot in savings and retirement every month. That doesn’t mean I want to feel like I’m living paycheck to paycheck just because our mortgage is so high. We are still young, I’m 30 and the husband is 28.

We don’t have a kid yet, the husband is waiting for us to be making about $5,000 more per year before he will start a family (that’s a whole different topic!). So sure, we could afford the $500 now, but if you doesn’t think we make enough to afford daycare as is, then spending an extra $500 per month for a mortgage payment means that instead of us making an extra $5,000 a year in order to afford daycare (and still save as much as we already do), we would need to make an extra $11,000. I wasn’t willing to wait that long. I’ve been looking for a new job that pays more for over a year now, it’s slow going.

Plus, we are working on renovating the house. So while we plan to put extra towards the mortgage each month in order to pay it off early. That extra money is instead financing all the changes we make to the house. Once we finish, (only 2 bathrooms to go!) we will start paying extra on the mortgage.

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Remember, whatever you pay extra on a 5% mortgage is like getting a 5% return on that money.

Right now E-Trade’s “High-Yield” account is returning 1.7%.

Ian

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in a similar situation – opted for the 25 year loan as a compromise.

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“We were thinking about refinancing, but then our old mortgage broker recommended against it. He said that the prepayments lowered our effective interest rate”

RP – I am sorry to be critical, but this is nonsense. Your rate is your rate, regardless of prepayments. Of course, prepaying principal saves you interest, but the rate used to calculate the next month’s interest doesn’t change on a fixed loan. I’ve heard the same nonsense when people talk about 30 year mortgages having an effective rate of 105% or some other ridiculous number.

If one can refinance at no cost, no closing fees, it’s worth it to save 1/8% in your rate, so long as the time it takes you to gather your paperwork doesn’t outweigh that savings. If there are fees, then of course there’s some math to do.

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I recently refinanced when i moved house. Although i could easily afford a shorter term, i went with a 25 year term, (age until retirement age so all allowed). But i make regular overpayments.

The reason i did this, is not so much if my income drops (although it has recently due to downturn), it’s due to future possible increases in expenses, eg possible medical expenses and kids college etc.

We felt more secure that way. I’m with you on that one JD

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We already have a good interest rate on a 30 yr and have decided not to refinance to a 15 year for the same reason. However, like J.D. we pay additional towards the principle (not prepayments, but towards the principle). At the rate we’re going, we’ll have paid off our 30-year mortgage in about 12 years. When we first bought the home we couldn’t have afforded less than a 30 year.

On a related note, my favorite mortgage calculator is a loan amortization template that comes with Microsoft Excel. What I love about it is I can enter specific values of additional principle payments to any month and see the affects that would make. I highly recommend checking it out. I even made a short video explaining how to use it.

http://www.yourtwobits.com/154/how-to-calculate-a-loan-or-mortgage-with-excel

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It’s simple. If your income is stable, then choose the 15 year option. If not, then go with the 30.

I just finished refinancing and ended up with a 30 year at 4.5%. I had a 10 year at 4.99%, so the savings wasn’t as much as yours, but the main reason I refinanced was to drop the payment from $2650 to $1145. I feel that I could lose my job at any second, and the lower payment allows me to survive 2 to 3 times longer than with the higher payment.

I think you did the right thing.

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