# Why we chose a 30-year mortgage

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.

## 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.

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### There are 125 comments to "Why we chose a 30-year mortgage".

1. Writer's Coin says 19 March 2009 at 05:08

Right off the bat, simply by looking at how much you pay, I would’ve said the 15-year mortgage makes more sense.

But now that I’ve seen these spreadsheet numbers, it’s hard to argue with what you’ve chosen: now you have the statistical benefits of the 15-year mortgage with the “cushion” that comes with a 30-year mortg.

I say you did well. It’s like switching banks for 0.05% more interest when the bank is way across town in a shady neighborhood. I’ll take the lower interest and safety every time.

2. Stephen Popick says 19 March 2009 at 05:15

For comparison’s sake, this resident economist of GRS and AWESOME FORUMS ADMIN (Cheap Plug), also refinanced at the same time JD. We actually found out the other was refinancing over a series of emails. Folks, I think that is a sign to refinance!

Back on topic, unlike JD, my wife and I choose to refinance into a 15 year product. We had 13 years left on a 15 year HEL and 24 years left on a 30 year fixed.

We looked at a 15,20,and 30 year product. Based on our unique situation, we could save approximately 200 a month with the 15 yr, about 350 w/ 20 yr, and about 550 w/ 30 year.

Why did we choose to go with the 15 year product and why might that differ from JD’s decision? Here’s what I think:

1) Our families are at different stages: JD’s turning 40, I’m turning 30.

2) Both my wife and I work within the US government, very stable employment. Our cash flow is fine

3) We have a tenant which brings us extra cash flow anyways.

4) And I’m obsessed about retiring early and a critical component is no mortgage payment!

I suppose that it goes back to the mantra “Do what works best for you” right?
[b]
HOWEVER, I do think JD missed one very important calculation. Money saved today is not the same as money saved tomorrow. If you are going to do a really bang up comparison, you have to discount the value of future savings, not ONLY by inflation but also by some intrinsic discount factor. See JD, I *am* a nerdy economist!)
[/b]

3. CF says 19 March 2009 at 05:23

JD, I’ve been going through the same scenario in my head as well. We’re at about the exact same stage as you (5 years into a 30 yr mortgage), and I will probably do the same and take the 30 year refinance as a “hedge” against any bumps down the road. We have a great rate already (5.25), so I’ve hesitated since rates aren’t that much different. The Fed’s actions yesterday might drop the rates further, but most lenders have so many applications that they have little incentive to drop them any further. Thanks for the post.

4. the weakonomist says 19 March 2009 at 05:24

I’d gladly pay \$3,000 to have some “insurance” in case the flow of money slows or stops. Being aggressive could lead down a hole you can’t get out of. Best not to chase to best scenario, because it forces you make assumptions you might not be able to live up to. Conservatism for the win my friend!

5. Heather says 19 March 2009 at 05:26

hmmm… In the current economy, is saving \$50 a month worth possibly being able to pay a smaller mortgage amount if needed? I would honestly say NO!!! Sometimes peace of mind is priceless. That said, I am the proud owner of a 15 year mortgage. My husband and I will have our home paid off before I am 40 and I am a stay at home mom. We refinanced when we were both working and thankfully have been able to afford the 15 year mortgage. Sometimes I think it would have been better to get a 30 year. Then I think of all the stuff we can do when our home is paid off — like pay for our children’s college because we won’t have a mortgage AND I will be once again working. Now I just need to convince myself to stay in this house when it is paid off!!

6. Katherine says 19 March 2009 at 05:34

While I am far from buying a home, I made the same choice with buying a car last year. My husband and I opted for a 4 year loan because we knew we could comfortably make the payments, even though we were both students. Now that he has graduated and been looking for a job for three months, I am very glad that we have the lower payments. As soon as he gets a job, though, we plan to pay extra and pay it off FAST.

In summary, I love the security of lower payments and the good feelings I get by paying extra.

7. Brad says 19 March 2009 at 05:35

I think you did the right thing. You basically have your own insurance policy on your lifestyle. Sure it costs a bit extra wiggle room allows for when life happens.

I think the key is that if a person has self discipline to make the extra payments they should go with a longer mortgage and overpay each month.
If a person does not, than a shorter mortgage might be better.

8. Scott says 19 March 2009 at 05:45

We’re just finishing up a refi and went through the same debate. We made the same conclusion that the 30 year (while still paying more) was the better decision even though we could have ‘afforded’ the 15 year. Our original goal in doing the refi was to lower our fixed expenses (while saving interest costs over the life of the loan) in case one of us loses our job going forward and we didn’t like the idea of having the required higher payment.

9. Keith says 19 March 2009 at 05:50

My wife and I just completed a refinancing in early January that allowed us to combine 2 15-yr HIL loans and our 30-yr mortgage into one mortgage loan. We had about 10 years left to pay on the 15-yr loans and 25 years to go on the 30-yr. We lowered the rates on the loans from 5.375 to 5.125 and went again with a 30-yr loan. It saved us about \$200 a month in our payment, though after I bank that savings this year for some cushion I am planning on paying that savings as extra payments starting next year. We could have afforded to go with a 20-yr loan and saved a little more on interest, but I opted for the 30-yr for the same reason as JD. My job is tied to the housing industry and I wanted to have added cushion of a lower payment to fall back on. I am still happy with my decision as it accomplished my main two goals, one loan and the lower payment to fall back on. If rates drop here again I may just consider doing it again. A drop to 4.5 would save me another \$20,000 over the life of the loan.

10. ABCs of Investing says 19 March 2009 at 05:51

I use the same logic as you and have a lower monthly payment. We do a lot of accelerated extra payments on top of that.

One thing to keep in mind when considering refi is that if you are going to pay it off early, that will reduce any benefits from refinancing. Most mortgage calculators out there assume you don’t make any extra payments.

Extra payments save on interest which means that lowering that interest rate is less beneficial if you are paying the mortgage off early. Just something to keep in mind when doing your calculations.

11. Sceptor says 19 March 2009 at 05:53

JD,
Why don’t you switch your payments to bi-weekly??

If you apply this and accelerate your 30 year mortgage that will really make a difference. I don’t like the idea of monthly payments when bi-weekly is usually a small % more. Bi-Weekly makes a huge impact on overall interest paid and shortens mortgage length as byproduct.

12. Waves says 19 March 2009 at 05:54

I noticed you compared the 15 yr w/ acceleration to the 15 yr wo/ acceleration. I think you should be comparing it to what you actually chose. It would save you nearly 10k if you had chose to do the 15 year plan w/acceleration.

In the comparison you also said it would “only” save 6k (10k if you compare to what you chose). It is interesting how as you have moved out of debt that a 6k savings is not as big a deal to you anymore.

13. Michele says 19 March 2009 at 05:55

We chose a 15-year mortgage 8 years ago. We refinanced about 1 1/2 years later for another 15-year mortgage with a lower rate. We now have 8 1/2 years left to pay off our mortgage. To date, we’ve never had a problem paying the higher dollar amount even going down to one income. We have always kept an emergency fund and have lots of money socked away in retirement. If a catastophic emergency happened, we’d still be fine, so we opted for the lower interest rate.

14. April Dykman says 19 March 2009 at 05:55

We’re planning to do the same thing you’re doing–30 year mortgage, paying extra every month.

I want the safety net. I like knowing that we can pay the bills on one salary, both for piece of mind, and because I’m 27 and kids are probably in the 5-year plan. I want the options to return to work part time or maybe not return at all and freelance. Either way, the closer we are to living off of one salary, the more choices we have–whether it’s being a SAHM or starting a business.

15. Chett says 19 March 2009 at 06:00

J.D.,

We did the exact same thing last summer. We opted for a longer term and are putting extra money towards our mortgage each month. In the past, when we were in debt, we would have chosen the longer term for a lower payment, made some shallow promise to ourselves we would pay more when we could and then filled whatever wiggle room we had left with monthly payments for more crap that we didn’t need.

Now we have clear goals and paying down our mortgage is one of them. I think leaving yourself some room “just in case” was a sound decision.

16. Do You Dave Ramsey? says 19 March 2009 at 06:01

Nicely done JD. The key point I’d illustrate is the diligence you put into the process. You clearly ran the numbers but also factored in “off sheet” risks and possibilities as well.

Too many people look for the lowest payment so they can obligate those newly freed funds elsewhere.

Rather, you took advantage of the lower interest rates to do 2 things – improve your payment power AND maximises or at least preserves your buffer.

I think that’s a winning combo

17. Deborah says 19 March 2009 at 06:02

“If nothing happens along the way, then this will have been a poor choice.”

I don’t think so – I think having the breathing room and peace of mind will be worth the financial decision in the long run. Maybe it won’t be as financially rewarding – but you’re obviously in a place that’s just as much about emotional/mental rewards as it is about financial.

Safety and Security are worth it.

We were on the verge of refinancing (we’re also 5 yrs into a 30 yr mortgage) when our home value fell down a gorge and got eaten by hyenas. Now we’d be looking at paying PMI again, so we’re holding off a little longer – and probably missing the rock bottom interest rates.

18. Tom Murin says 19 March 2009 at 06:14

We refinanced from a 30 to a 15 a few years ago. While we love building equity faster – we now regret the decision based on our cash flow situation. In hindsight would have felt better staying with the 30 and making additional payments (which we were already doing).

19. Shaz says 19 March 2009 at 06:15

Bravo. You can’t make decisions by the numbers alone!

20. J. says 19 March 2009 at 06:20

Are you kidding me? Absolutely you made the right choice–this current financial crisis is an excellent case in point. But any sort of, god forbid, medical emergency, house emergency, family emergency, or job emergency can tip anybody over the edge if there is no buffer. It’s one of the main points I love to read about on your blog, as it reinforced my deep seated life philosophy. Congrats on the savings!

21. Neal Frankle says 19 March 2009 at 06:24

The choice you made gives you tremendous flexibility and lots of “sleep at night” value.

I think it was a smart move.

A mortgage is the biggest debt most of us ever have. As a result, we have to consider everything – not just the numbers.

22. Adam @ Checkbook Diaries says 19 March 2009 at 06:24

Hi J.D. We are going to be refinancing soon and plan to do the same thing. Although we should be able to afford reducing the term to 15 years, we like the idea of knowing that if need be we can simply pay the “minimum” on the mortgage each month and have some extra money for emergencies. In our case, we are expecting our first child and want to be sure that we have a little extra wiggle room each month in case of unanticipated expenses. Our goal is to put the extra money saved in P&I into our consumer debt snowball, then accelerate our emergency fund, and then repay the mortgage faster. But if we didn’t have consumer debt and had a full emergency fund, it would all be going to the mortgage as extra on the principal.

23. DP says 19 March 2009 at 06:26

could you please post the spreadsheet that led you to these numbers?

I also agree w/ your plan.. But the fact that you are paying 10K for the “insurance” option does seem a little steep..

24. Barb1954 says 19 March 2009 at 06:31

I would not want to restart my mortgage at 30 years after several years of payments. All that extra interest is just money out the window.

My husband and I bought our house 19.5 years ago and have refinanced it three times. When we purchased in 1989, the interest rate was 9.75%. We refinanced to another 30-year loan a couple years later when rates dropped 2% points. Because we’d put 10% down and our house had appreciated in value, we now had at least 20% equity and were able to drop the PMI insurance. Several years later, when rates dropped to around 6%, we refinanced for a 15-year (less time than we had left on our mortgage). The new payment was perhaps \$100 more a month. Five years ago, we refinanced to a 10-year mortgage for 4.625% Note that mortgage brokers don’t offer separate rates for a 10-year mortgage, so we’re paying the same rate as for a 15-year loan. However, we could afford the few hundred dollars more a month for the shorter term and wanted to have our house paid for ASAP.

If we just paid on schedule, our house would be paid off 24 years after we bought it. As it is, we plan to apply some sales commission money and an inheritance my husband will be receiving in a few months against principal. The sooner we can eliminate that \$989 monthly P&I expense from our budget the happier we’ll be. Unfortunately, we live in Wisconsin so our property taxes are still \$6,400/year.

When making mortgage decisions, I think it all depends on what your goals are. How important is it to have a paid off home vs more discretionary income each month?

When I bought my new ’96 Honda Civic (with only 83k miles, I still drive it), I took out a 4-year loan. But because I planned to go to graduate school and wasn’t sure how much income I’d have while doing so, during the third year, I made a car payment every time I got paid — paying the car off in three years.

I’m one of those people who hate, hate, hate owing money. Thankfully my husband is the same way. That mindset has helped us make good financial decisions throughout our 30 years of marriage and kept us from overextending ourselves on house, car, and other big purchases. We’d rather have money in the bank than toys in the garage or house.

25. sandy says 19 March 2009 at 06:32

We bought our place 10 years ago (this mmonth!.)We looked at the 30 and 15 yr options at the time, and went with the 30 year, with the idea that we could always accelerate payments, and having a lower monthly payment if we needed to.
We have put extra toward the principal most months. When hubby got a bonus or refund or some other chunk fell in our laps, a lot of it went straight to mortgage. Now, we are looking at likely being done with a mortgage by end of 2010. We’ll be 48. So, 12 years of mortgage. While the cash will likely go straight to daughter’s college, at least it willbe there, and we’ll always have that roof over our heads. Actually, we’ll likely feel really rich, as we’ll have not only the regular mortgage, but the prepay amount as well. Looking forward to that!

26. nickel says 19 March 2009 at 06:33

We did a 15 year @ 4.875% when we refinanced in Feb 2008 and we’re pre-paying it. That being said, I was drooling over the possibility of 30 yr fixed rates @ 4% (this was batted around a few months ago). Talk about an inflation hedge! If I were able to get a rate that low for that long, I would pay it off as slowly as humanly possible. All signs are pointing toward increased inflation down the road, which would rapidly erode the ‘real’ cost of our mortgage.

All of this being said, your strategy makes sense from the standpoint of mitigating your risks (and making yourself sleep better at night).

27. leigh says 19 March 2009 at 06:35

we did that with a car loan several years ago. and sure enough, halfway into it, we incurred nearly \$20k in medical bills and then my husband lost his job.

adjusting to one income and scant unemployment benefits was rough enough, at least we didn’t have to worry about making our regular high car payment. that cushion was worth it for us.

28. J.D. says 19 March 2009 at 06:40

@DP (#23)
I wish I could share my spreadsheet, but I can’t. It was an ad hoc affair created for this post, and I ditched it after I was done. I regret this because it would have been fun to share and it occurred to me that if I have any math errors, I’m not going to be able to determine how they occurred. (I don’t think I have any errors, but you never know.)

Next time I do something like this, I’ll save the spreadsheet.

29. John Ingle says 19 March 2009 at 06:41

Hey J.D.! I’m a new reader and I love everything I’ve seen so far! Keep up the good work. I’m glad you posted this because I’d been wondering about the numbers for a while and simply hadn’t run them yet. However, I do have a question for you if you’re up to it. How might the numbers (and your decision) change if you invested the difference between the refinanced 30 year accelerate and non-accelerated mortgage payments?

I know that you can’t guarantee a particular return on investment, but if you average a decent performance over the term of the mortgage you might come out ahead. Any thoughts?

30. Budgie says 19 March 2009 at 06:43

Great point, JD. We did the same thing with our mortgage when we took it out last year. We could have afforded the 15-year term, but we opted for the 30-year term for peace of mind. We’ve been paying a significant amount extra towards principal every month, but we didn’t want to take the risk that something could happen and we couldn’t pay our mortgage. What if one of us lost our jobs? We couldn’t pay the 15-year term mortgage with one income, and that’s not a risk we were willing to take. It seems to work the same way as an insurance policy: You’re paying more for seemingly nothing, but you’re glad you did if something bad happens. And when it’s your house you’re talking about, that’s a big thing at stake!

31. Nancy says 19 March 2009 at 06:45

We’re in the middle of refinancing from a 30 year mortgage (6 years in) to a 15 year. If all goes well and we close in the next couple of weeks, we’ll have dropped 2 whole percentage points and dropped our monthly payment by around \$400. Over the length of the mortgage, we will be saving over \$100K in interest.

The factors that weighed into choosing the 15 year over the 30 year were the following.

1. The interest rate was lower on the 15 year, which increased the amount of savings.
2. The monthly payment was lower than our current payment–therefore we were still reducing risk (compared to our current position) if our financial situation changes for the worst.
3. In our experience, we do better with “mandatory” choices than “voluntary” ones. We could say we’d pay an accelerated rate each month, but it would be easy to let the extra payments slide because other “expenses” popped up. By making the acceleration a non-negotiable amount, we’ll remain committed to it over time.

32. Troy says 19 March 2009 at 06:45

JD

Pay no attention to your detractors.

I OWN a mortgage company, and you chose correctly.

Ammoritization means zilch. It only determines the amount to principal on each payment.

If you pay extra, you create your own ammoritization.

The fact you opted for a 30 vs 15 loan only means your MINIMUM payment is less.

that allows for flexibility. A 30 gives you choices. You can pay, or not. you can turn it into a 15, or a 109, or a 20 or a 30 simply based on your payment schedule.

a shorter term affors no such flexibility.

the difference in interest rate is minimal. Addind additional principal payments only lessens the interest rate differences impact.

On a different note. You should have waited. I told many of my clients to have patience.

You could now get the same loan for .5-.75% less.

33. mwarden says 19 March 2009 at 06:51

@JD, you are doing the right thing. The small savings is not worth committing to the 15 year repayment period. I would pay the extra \$3k to have the freedom to use that money more wisely, should a more wise decision come across.

34. RT says 19 March 2009 at 06:54

We refied in Feb of last year. We rolled two mortgages (30yr regular and 15yr HELOC) year mortgage into a standard 15 year loan.

Let me tell you, it was scary and exciting to move into a 15 year mortgage. I had the same concerns you did about having a cushion in case something happened. It took about 3 payments before I really felt comfortable with the new bill but then I got excited with the prospect that we’ll own our house free and clear before we’re 45.

It works best for us at this point because we’re DINKs (Dual Income, No Kids) and we have minimal expenses. If we had kids, I probably wouldn’t have felt comfortable getting into that loan because of the drastic change to the budget. It raised our payment \$500.

35. aa says 19 March 2009 at 07:00

It’s better to be safe than sorry.

36. Laura says 19 March 2009 at 07:05

If you want to play around with different refi scenarios, this site has some great mortgage spreadsheets:

We have a 15 year mortgage at 5.75% that we pay extra on. We’ve considered refinancing to a 30 for the same reasons you mentioned, but we’re so close to having it paid off (December 2010!) we decided it wouldn’t be worth the headache.

37. ldk says 19 March 2009 at 07:05

We opted to not use a mortgage product at all 12 years ago when we built our home. We financed it with 25% down and the rest on a secured line of credit at prime less a quarter. Minimum payment of interest only. Our safety net (which we never used) was that we would have only had to make the minimum payment (about \$600/month)had our income decreased for any reason. We made regular monthly payments of \$1200/month (\$600 of which went immediately to reduce the principal) with the intention of paying it off in 15 years. Some bonuses came our way which we directed to the principal (without penalty) and we were actually able to become ‘housing debt free’ about 4 years ahead of schedule.

38. mjfrombuffalo says 19 March 2009 at 07:13

I find it odd you didn’t mention 20-year mortgages. While not as talked-about as 15- and 30-year mortgages, they’re available and make a very happy medium when you’re balancing interest and payments.

39. Trevor Hammond says 19 March 2009 at 07:24

JD – love your analysis, and your blog as always. I’ve been helping families make this same decision for over 10 years. The way I explain it to clients is…”how do you manage your risk?”. Choosing a loan product, and term, is really about managing risk. This is exactly what you did.
While a 15-year fixed-rate mortgage can save you thousands over the life of the loan…too often people get caught up in the numbers and forget to “real life” factor. These days I get calls weekly from great clients and friends who have lost jobs or taken pay cuts. People rarely stay in a home 15 years…the average is somewhere around 7 years still.
We teach a 4-step Money Priority Model to help families follow a simple process with their cash.
1. Cash-Cushion
2. Pay Consumer Debt Off
3. Build Liquidity
4. Pay off mortgage/house

Life (and now the news), reminds us daily that too few families have a sufficient cash-cushion for emergencies, too much consumer debt eating away their paychecks, and not nearly enough “liquidity” in their finances to weather storms.
Manage risk, and make sure all the fundamentals to financial success are in order before giving all your extra money back to the bank.
Just my “2 cents”. Thanks for everything!

40. RP says 19 March 2009 at 07:35

We got a 30-year 5.5% mortgage when we bought our house 6 years ago, and have been prepaying it from the beginning. We were thinking about refinancing, but then our old mortgage broker recommended against it. He said that the prepayments lowered our effective interest rate; so we hauled out our trusty spreadsheet where all of our payments are listed and had it solve for our interest rate. Bingo! 3.79%, even if we make no more prepayments.

So, unless mortgage rates go way down, we’ll shelve this idea for now and concentrate on rebuilding our savings from the plundering they underwent during our bathroom rehab project and getting ready for the day when our 8-year-old car goes kaput.

41. mary says 19 March 2009 at 07:37

What you’re doing basically is allowing yourself some insurance. Although it looks like you could save more money with the 15 yr mortgage, following this line of thought you could also save money by not paying for health insurance, life insurance, etc., AS LONG AS YOU NEVER NEED. Hindsight’s 20/20.

42. mary says 19 March 2009 at 07:38

What you’re doing basically is allowing yourself some insurance. Although it looks like you could save more money with the 15 yr mortgage, following this line of thought you could also save money by not paying for health insurance, life insurance, etc., AS LONG AS YOU NEVER NEED IT. Hindsight’s 20/20.

43. Kristen says 19 March 2009 at 07:39

We have a business loan, and 1.5 years ago, opted to write up our purchase contract over 8 years with a minimum \$5K per month payment, rather than about 4 years at \$10K, just to be safe. This was the absolute right thing for us to do. For the first year, we were able to sock away that ‘extra’ \$5K per month, but in September, business largely dried up. We’ll be able to survive because we were conservative, and we were able to keep some of that money in the bank as a cushion.

We’ll be refinancing our house here in the next few weeks, starting our 30 year clock over after 8 years on our loan… We’ll do the 30 year fixed loan again, and keep our options open for that ‘extra’ cash. I have no doubt we’ll pay extra on the mortgage, at least to knock enough time down to break even with where we are now, but I want that flexibility.

Peace of mind is worth something, too.

44. Weston says 19 March 2009 at 07:43

Well since the Spreadsheet was trashed does anyone know of any online calculators that do essentially the same sort of comparisons. I know that there a ton of mortgage calculators on the net but I don’t know of any that do this particular calculation.

Since I (and clearly many many others) are considering the same factors as J.D. I was hoping someone could point me in the right direction.

45. Ian says 19 March 2009 at 07:45

Great Post JD,

You make a good argument with valid points. You’re paying extra anyway and you are playing it safe in uncertain financial times.

I like to make three other comments:

1. It concerns me how many write (including you, JD) that by extending the length of their mortgage you “Save” money every month. You should remove that white lie from your vocabulary. You are not saving money per month, your paying extra to pay that money later. It’s like walking up to a car salesman and telling home you want a \$200 monthly note (car buying mistake #1).

2. Maybe I’m just not as disciplined as the rest of you, but I’m sure most people intend to pay off most loans early and don’t. I prefer to follow the advice akin to putting away raises so it’s like you never got them. Refinance with a lower rate, and keep the payments as close to the same as possible. Your lifestyle stays the same, your loan is paid off earlier, and you save thousands.

3. Had you considered a 20 year note? It’s a compromise of this whole 30 v. 15 discussion and likely the path I would’ve taken.

FWIW, I am 5 years into a 30-yr and 5%. I can’t afford to pay extra currently, but it is a financial goal of mine. I can’t imagine refinancing unless, I can get 4%.

Thanks for bringing up the discussion.

Ian

46. brooklynchick says 19 March 2009 at 07:46

If the past few months have taught me anything, its that there is NO SUCH THING as a “secure” job. Having your fixed costs at a level that can be maintained on ONE salary is the best plan you could have, IMHO. I think you did exactly the right thing, esp. if your mortgage has no penalties for early payments.

47. Linear Girl says 19 March 2009 at 07:47

I’d like to challenge you to run and consider one more set of numbers. How much more would you need to accelerate your payments on your new loan to “break even” with the 15-year loan? In other words, how much extra would you need to pay each month at 4.96% in order to make the total interest paid over the life of the loan equal to the \$76,985.03 you would pay on the accelerated 15-year plan? I doubt (though I don’t know, hence your running of the numbers, which suddently sounds very Hemingway-esque) it would be a significant increase and it would eliminate the cost of your increased security.

For what it’s worth, we too chose the security of a longer term (and lower priced house) in order to be able to afford the mortgage on a single income, and that has been useful twice in the nine years we’ve owned the house.

48. SV says 19 March 2009 at 08:02

This may have already been mentioned, but have you considered tax deductions for the interest on your mortgage? The 15-year loan would have saved you \$8,966.61 in interest, but if this interest is tax deductible, the amount saved with the 15-year loan will effectively be less than this, won’t it?

49. Brian says 19 March 2009 at 08:07

Just because something feels good doesn’t necessarily make it the correct thing to do. Paying down a 30 year mortgage may feel safe, but nothing is safer than living within your means while aggressively paying off a fifteen year mortgage. Paying less money for the same asset just makes sense. Its worth the sacrifice to be beholden to no one.

50. Karen says 19 March 2009 at 08:07

@Ian: I can’t speak for the rest of the commenters, but we took a 30-year term on a \$50k mortgage and are on track to have the loan paid off in November after only 15 months. The only discipline involved was setting up an automatic payment through our bank.

If the worst happens, we’ll call the bank and reduce our payment to the minimum until we we’re back on our feet.

51. JC says 19 March 2009 at 08:10

JD and Troy:

I am considering purchasing a house in the next six months. It seems to me that that assuming the spread between the 15 year and 30 mortgage is neglible, opting for a longer mortgage term is always preferable that is if prepaying on your amortization schedule is allowed because of the flexibility it allows.

I would like to hear thoughts on are there any indirect disadvantages to choosing a 30 year mortgage such as insurance premiums, credit scores, etc. Any thoughts?

52. dawn says 19 March 2009 at 08:16

Like you, i chose a 30-year mortgage which i prepay on rather than spending \$4,000 or so in closing costs to refinance, or to get a lower rate on a 15-year loan.

If, God forbid, i lost my job, i sure wouldn’t want to be locked into the higher monthly payments of a 15-year loan.

I am very disciplined and throw an extra \$425 monthly toward my mortgage (current balance \$65k) but i also enjoy the flexibility of knowing i could pull back on that in the event of a financial crisis.

53. J.D. says 19 March 2009 at 08:22

If you’re wanting to do similar math, check out the mortgage calculators at Dinktown.

54. MGA says 19 March 2009 at 08:25

I chose the 30 year mortgage that I prepay when I feel financially secure enough to prepay (which hasn’t been for several months given the economy). I’m single, and don’t have a spouse’s income to fall back on. So if worse comes to worse, I can take a low paying job and hopefully still scrape enough together to cover my 30 year mortgage payment.

55. Kevin says 19 March 2009 at 08:26

Am I the only one here who advocates taking a 30-year mortgage, and NOT paying any extra on it? My wife and I have 27.5 years left on a 30 year mortgage, and we’re not making any extra payments at all.

Any extra cash we have get invested in the record-low markets. Why would you be in a rush to pay down a 4% loan when you have the option of investing in the markets at 1997 levels?

Heck, you can even deduct your mortgage interest! We can’t do that up here in Canada, and I STILL think this is a better plan.

56. Nolan Matthias says 19 March 2009 at 08:33

Have you looked at what would happen if you took the monthly difference between the 15 and the 30 year mortgage payments and invested it at different hypothetical returns as opposed to accelerating the payments? You might be surprised by the overall net worth difference at the end.

57. J.D. says 19 March 2009 at 08:33

@Kevin (#54)
You’re not the only one who advocates this. The “take a low-interest 30-year loan and make minimum payments” is actually the mathematically ideal route, from what I understand, because of the effects of inflation.

58. Karen says 19 March 2009 at 08:33

Chances are the market will recover before your mortgage is paid off, Kevin. In the eight months I have left on my mortgage, however, a significant recovery is highly debatable, so I’m willing to take the risk.

59. Dave says 19 March 2009 at 08:35

I also think that it’s important to factor in how long you intend to keep the home (market fluctuating factors aside). If you feel that you’re likely to move in 3-7 years, it changes the scenario significantly…

60. I Was Broke. Now I'm Not. says 19 March 2009 at 08:42

Great numbers rundown. I’d say it’s worth a few thousand dollars over 30 years to know your risk is lower if something happens to your income.

61. Mark Wolfinger says 19 March 2009 at 08:56

“Did we make the wrong decision? Time will tell. If nothing happens along the way, then this will have been a poor choice.”

I don’t agree.

It may be human nature to do so, but you cannot (ok, should not) judge a decision solely by the results of that decision.

You made a decision to take a 30-year mortgage and that was a good decision, based on WHAT YOU KNOW NOW. How else can you decide? You considered the facts, considered the alternatives, and chose. That is the correct procedure.

If do not want to second-guess everything in your life. You appear to have everything under control. Congratulations. You made a good choice. If, looking back from the future, something else would have worked out better, that does NOT mean you made the wrong decision.

Mark

62. KS says 19 March 2009 at 08:56

@Dave(58): How would you factor in moving in 3-7 years? I just went through some phone calls and scenarios yesterday and am not sure what to do. We’ve been paying a little extra/month (now \$100), 4 years into a 30 year mortgage at 6.35%. I have a secure job and we live on my salary. The 30 year fixed mortgages I’ve seen only drop the rate by 1 point; if we go to 15, I could get well below 5. But I spent yesterday trying to figure out what another 30 year mortgage would do if we could could take even more and put it against the principal. And folding in closing costs…makes my head spin.

63. Libby says 19 March 2009 at 08:56

I’ve recently started following your blog, and this topic is very close to home. We are also refinancing, and we chose to go to the 30 year also. They have been laying off workers at my husband’s work, and so we want the extra cushion as well. We plan on paying off the mortgage by making extra payments, but we want to make sure we aren’t tied in to those extra payments. I’d say you made the right choice!

64. Wise Money Matters says 19 March 2009 at 08:56

I chose the 30 year option as well for this very reason when I bought my last house. I wanted the safety net in case something bad happened. Luckily, I made the right choice. My company recently handed out 10% pay cuts to everyone due to the economy as well as laid off plenty of people. I’m now worried about my job and am making the minimum payments while putting extra money into my emergency fund. With a 15 year mortgage, we would be strapped quite a bit more in this situation.

65. Limber says 19 March 2009 at 09:02

Our over simplified philosophy in regard to a 15 year loan is, we have the next 5-10 years to grab one if our financial situation makes sense. It’s an option to keep in mind when it’s closer to the kid’s college years.

I think you made the best decision.

66. KF says 19 March 2009 at 09:09

If I were you two, I would have done the 15-year mortgage with your normal accelerated payments. I think the 30-year mortgage is a product of pessimistic, deficit thinking. You are both just fine financially, and you will continue to be just fine financially. This is because both of you now have the appropriate mind set about money, saving, investing and planning for the long-term. Even if crisis were to strike and you were living off of one income, your overall financial lives are conservative enough and stable enough that you would still be able to pay the 15-year mortgage. A difference of a few hundred dollars would never kill your budget. You’d find other ways to cut, or you’d find a way to increase your earning by a few hundred dollars. Once one’s finances are stable, such small amounts of money no longer present a crisis. I’m a professional, but if I had to, I could earn that by offering to babysit a couple of nights a week!

67. Jason B says 19 March 2009 at 09:15

I went with a 15 year loan because I currently have tenants and because even if I lost both and couldn’t replace them, I would just have to reduce some savings or extra car loan payoff. Of course, if I lost my job and couldn’t replace it within 3 months or lost my job and tenants, things could start to get ugly. I’m single, so no matter what there’s only one real income. I’m taking more risk for reward. But…….

I definitely saw that the biggest impact on overall interest paid was the size of the monthly payment, much more so than the decrease in interest rate from 6.375% to 5.0%

68. sandi_k says 19 March 2009 at 09:25

I like the way your readers think, JD. They’ve made most of my points for me. 🙂

Our philosophy is multi-dimensional: reduce risk, enforce savings, and diversify.

When we bought our house, we had a 30 year loan, at 7.625%. We refinanced in 2004 with a 20 year loan (GREAT MIDDLE GROUND between the 15/30 options!).

We just closed last week on our new 15 year fixed, at 4.25%, 1 point paid. We also took out some cash, because too much of our net worth was tied up in the house.

Our new payments are ~ \$100 more each month, but we’re still on track in terms of TIME. We have not re-set our mortgage, which would feel like going “backwards” to me. We also have stashed the cash at ING, so we have ~ 14 months of expenses in savings.

We still “own” 55% of our house (an advantage of having bought during the 1992 recession, and not having borrowed against the equity to date). We now have cash in hand. We have enforced savings via an aggressively low-rate mortgage. We are using some of the cash to pay off our two low-balance auto loans, so we’ll be completely debt free, other than the house.

So, having a “guiding philosophy” has been very helpful in the refinancing process. It helped us determine what the optimal intersection is between cash flow and obligation.

Happily, even the new mortgage can be paid on one salary. We too hope to pre-pay some of the principal, and have it paid off in 8 years. If we pre-pay \$200 per month the first year, and raise that amount by 10% each year, we can do it. How cool would it be to have a paid-off house at 51?

And then we can use the “catch up” provisions on my 403(b) and DH’s IRAs with our money that no longer goes to the mortgage!

My favorite financial calculator site is here:

http://www.hughchou.org/calc/

There are all sorts of calculators, including the prepayment one on a conventional loan; amortization charts; a DRIP calculator; retirement calculator, etc…

We are still contributing 15% to our retirement (remember, diversify!) so we’re not passing up the “stock sale” currently going on.

Since you and Kris do not have kids, the 30 year isn’t a horrible choice. But I would have gone for the 15 year too, with only a difference of \$50 per month. 🙂

Sandi

69. mhb says 19 March 2009 at 09:25
The “poor choice” would have been to not refinance. I think this sounds like quibbling between two decent choices.

It’s interesting quibbling, but still.

70. J.D. says 19 March 2009 at 09:28

@mhb (#68)
Exactly. This brings to mind the difference between “maximizers” and “satisficers”. I’m usually a satisficer. I believe that, in general, it’s best to act now by making a good choice than to wait to make the best choice. There are times that I maximize, but in most cases I think it’s best to go with something good. Action beats inaction!

71. Steve Anderson says 19 March 2009 at 09:37

Yep… Perfect logic and the peace of mind that comes with knowing you have a cushion should you have financial problems in the future is worth the few extra \$\$\$ you’ll pay over the life of the loan. Good job!!

72. Jim says 19 March 2009 at 09:37

If you instead invested the additional principal payments and earned 8%, you would make back all the interest paid on the 30 year loan in 15 years. At the end of the mortgage, you would have over \$850,000 through investing rather than paying down the mortgage.

73. Shara says 19 March 2009 at 09:45

I’m with most of the people here agreeing with your decision. And I think Mark @60 has an important point about not going back and second guessing yourself later. My grandfather did that, looked back on all of his bad decisions that lost him money, and it made him miserable. Definitely learn from the past, but keep yourself facing forward.

15 years is a long time, and 30 years is even longer (about twice as long, give or take). A LOT can happen, and if you don’t have the money in your savings and investments to make you feel safe with the 15 year payment then you made the right decision. I recently refinanced as well and I was annoyed because I was hoping for rates to fall in another year or two because my financial situation would be different at that time and I would make different decisions. But it didn’t so I had to make the decision based on my situation NOW. That is exactly what you had to do. If you refinance in 3 years and your savings/investments are much larger you will likely make a different decision.

Either way you chose between two good situations. Congrats.

74. Karen says 19 March 2009 at 09:46

@Sandi (#67): Please explain the logic behind your statement that “too much of your net worth was tied up in the house.” I don’t understand that line of thinking.

75. Amber Warren says 19 March 2009 at 09:46

I love this post. We opted for a 30 year mortgage for a similar reason – you just don’t know what’s going to happen. I like that I can pay more on this mortgage and pay it off faster IF I have the funds, or pay what’s owed if one of us gets laid off (which has happened). Luckily I got right back on my feet, but it’s better to have a cushion I think.

I have a totally unrelated question: My ING savings account interest keeps dropping – rapidly. Is this happening to all the high-yield savings accounts? You did a post about this a while back. Do you have any tips? Should I move elsewhere or stick with them? When will they go back up?

76. Debbie M says 19 March 2009 at 09:50

I don’t have to guess what I would have done; I can tell you what I did: I was two years into a 30-year FHA loan and refinanced to a 15-year regular loan.

I had been paying \$100 extra per month, which was cutting off about 3 months every time I did it (during those early years anyway). After the refinance, my minimum payment went up only slightly, so I went with it because it saved me some interest. And my private mortgage insurance dropped drastically because of how much I’d managed to pay off during those first two years.

I didn’t worry too much about the cushion–my new payment seemed affordable. This was somewhat risky because it was just me buying my house (no back-up income), but I have a very stable job with the government (they do hiring freezes rather than lay-offs). Still, it’s possible I could hate this job and want to quit, but I do have some savings. And I have quite a bit of money contributed to a Roth IRA that could be withdrawn to make mortgage payments if necessary (enough to pay off the house, actually); contributions (though not dividends, capital gains, interest, etc.) can be withdrawn at any time without penalty.

One thing I might have been able to have done better is to have continued making additional payments. The interest rate was so low that I figured I could make more elsewhere. Obviously, I turned out to be wrong about that, since all the elsewheres I know about either paid less or plummeted! If I had paid more, the house would have been paid off this September (instead of four years from now), probably a good time for buying stocks. But I had thought that spreading out the buying would be more likely to be wise than to invest all the excess during the last 5.5 years before retirement. It was an okay guess except for being wrong!

So the best choice for me would probably have been to take the 15-year mortgage, but continue investing at least some of the extra money in the mortgage (though I think I did end up putting most of it into retirement accounts which is also a huge priority for me).

77. financialwizardess says 19 March 2009 at 10:06

JD, we went with the same logic you did. It’s somewhat reckless not to factor in the “what if” of losing income. 15 years is a long time and I think the odds are that you will change jobs, either voluntarily or involuntarily during that time.

I’ve found our system to be very flexible in that we’ve increased our payment amounts as our income has increased, but we’ve also cut back at times when we’ve had to help out family financially, and after the birth of both of our kids when I opted to take more time off without pay. Having flexibility is ultimately how I define financial “freedom”.

I think you made a good choice. We’ve contractually got ~24 years remaining on our 30 year mortgage, but at this rate we’ll pay it off in 2011. And if we’re ever in dire straits, we’ll ask the mortgage company to respread our mortgage over the remaining term and lower our payment significantly during times of need.

78. The Happy Rock says 19 March 2009 at 10:07

It boils down to whether the \$9,000 in savings over 14 years is worth the peace of mind and lower risk.

I suspect most people would say yes, because they don’t see the money. If people had to pay \$9,000 up front for the flexibility almost no one would do it would be my guess. Ah, the beauty of credit and ‘imaginary’ money.

Inflation and mortgages is a whole other tangent that could muddle the issue ever further.

79. DP says 19 March 2009 at 10:12

@JD (#28)

no big deal.. I was just wondering.. 🙂

I put together a spreadsheet that tells me what our payments would be for different rates and how much \$ it would cost in interest.. But adding the functionality to see how much we’d save by acceleration would have been nice… If I finish it up, I’ll send it on to you.. 🙂

Either way, thanks for all the great work.. have been reading for a few months and now I check it a few times a day.. 😀

80. Tyler Karaszewski says 19 March 2009 at 10:15

I wish I could get a decent house on *any* mortgage for \$2000/month. California housing prices are still ridiculously inflated. If I could get a 3br/2ba house in a decent neighborhood for that payment, even on a 30 year loan, I’d jump on it. Maybe in another year.

81. financialwizardess says 19 March 2009 at 10:19

@Karen, did you have any trouble finding a lender on \$50K for 30yr fixed? I assume I can call my bank and re-amortize my existing loan to lower the payments (Countrywide) if we were in financial trouble due to layoffs, injury, illness, etc.

But if not, Plan B was to refinance. We have a very low balance (<\$60K). I read somewhere that a loan under \$60K is non-traditional, so I wasn’t sure if we’re going to be unable to refinance such a small amount in the event of emergency. Was there anything we need to know about refi-ing such a small amount, or is it pretty much the same as a traditional loan?

82. Paul says 19 March 2009 at 10:20

@Karen (#73): @Sandi (#67): Please explain the logic behind your statement that “too much of your net worth was tied up in the house.” I don’t understand that line of thinking.

I’ve been thinking about this lately too. Taking \$100k from savings to pay down a mortgage gains me what? (I’m not interested in the interest rate arbitrage here, I’m thinking about risk.) Whether I have \$100k more equity in my house… or \$100k in the bank (but \$100k more in mortgage debt), what’s the difference in risk? If I lose my job and have to move to find a new job, I still have to use the \$100k from the savings account to pay off the mortgage, so… what’s the difference (aside from the interest rate arbitrage created by the difference between the mortgage rate and the savings rate)? Doesn’t this question more clearly address why someone would pre-pay a mortgage, but in a lump-sum sense instead of a monthly scrimp-and-save sense?

(Oh, and also please ignore resale value of the house. Let’s assume there’s no gain or loss on the house sale – which isn’t likely if housing prices continue to slide as this recession continues – but please ignore it for this risk discussion.)

If the answer is “you should keep the \$100k in savings because you have more spending flexibility in case of need”, then doesn’t that mean you shouldn’t pay down a mortgage either – you should save outside of your house by paying the minimum possible every month – in order to reduce risk by providing spending flexibility in case of need? Or is that what JD means in #56 above when he says “The “take a low-interest 30-year loan and make minimum payments” is actually the mathematically ideal route, from what I understand, because of the effects of inflation.

Not pre-paying your mortgage (but saving the extra payment amount) is both the mathematically ideal route, and the lowest risk? What’s to discuss then?

83. sandi_k says 19 March 2009 at 10:30

@Karen #73 asks: Please explain the logic behind your statement that “too much of your net worth was tied up in the house.” I don’t understand that line of thinking.

********************************************************

Our thinking is that diversification also means liquidity. Having been in our home for 15+ years, the appreciation in our net worth was NOT liquid.

We had ~8 months in liquid savings, and more than \$250K in free-and-clear equity in the house. With the values sliding, so does the equity. So we wanted to convert some of that equity into cash.

So we took out \$45K in cash. It instantly means we can pay off our last remaining debt (other than the mortgage) – our two car loans. And we add another \$30K in cash to our liquid savings.

Not having car loans will save us ~ \$700 per month in payments. The additional payment on the mortgage (due to the interest rate drop and the now-higher balance) is \$100 per month. So we can now funnel \$600 per month into “car replacement” funds.

Our monthly required costs have gone down, AND we have more cash on hand in the event of unforeseen emergencies.

This is what I meant in terms of having a strategy – at some point, having too much tied up in illiquid instruments is not part of a balanced approach, in our opinion.

Sandi

84. Karen says 19 March 2009 at 10:44

@80 (Paul): I see your point, but in our case, the peace of mind from having a paid-off house was worth the short-term risk of reducing our savings rate (we could still last for a little more than a year using our EF if the worst happened).

But, back to the idea that too much of one’s net worth is tied up in a house. I completely understand reallocating investments, but it just seems odd to include the money I have paid toward my primary residence.

@81 (Sandi): Okay, now I understand. As I tried to understand how to apply your thinking to my life, I couldn’t see the benefit, but the eradication of other debt makes sense. Our situation is different in that our house is our only remaining debt.

85. J.D. says 19 March 2009 at 10:54

@Paul (81)
There’s a psychological factor involved too, though. Left to my own devices, I wouldn’t prepay the mortgage. I’d save the amount allocated for prepayment in a high-yield account or else invest it. But Kris feels strongly that we ought to prepay the loan ASAP, and I feel that it’s a good (though not optimal) choice, so that’s what we’re doing. If it makes my wife happy, it makes me happy! 🙂

Plus, if we do pay the mortgage off early, there will tremendous peace of mind knowing that I have a great deal of flexibility.

86. Terrin says 19 March 2009 at 11:24

I highly disagree with Ian. Sure, you’d save money if you are able to stay with your acceleration plan. However, the extra you are paying is worth it for the flexibility of being able to pay a lower payment if needed. Peace of mind is worth something. In today’s uncertain times that much more so.

I bought a certified used Volkswagen recently. The interest rate was 2.99. The sales guy asked me would I rather have a 48 month loan or 60. I plan to pay it off well before the 48 months, but flexibility is a good thing. I’d even pay a percentage point higher for that.

87. Terrin says 19 March 2009 at 11:29

Using your savings to pre pay a mortgage especially in today’s times would be foolish. If you lost your job, you may have to file bankruptcy if you can’t find a replacement job soon enough. Assuming your savings was in an Erisa retirement account, that money would be protected in Bankruptcy. So, you could walk from the house, file Bankruptcy, and still keep your savings. If you use your savings to pay down the mortgage, the savings is gone. If the market drops enough, you might lose any equity that you have in your house. You’re not getting that back.

Paul write, “I’ve been thinking about this lately too. Taking \$100k from savings to pay down a mortgage gains me what? (I’m not interested in the interest rate arbitrage here, I’m thinking about risk.) Whether I have \$100k more equity in my house… or \$100k in the bank (but \$100k more in mortgage debt), what’s the difference in risk? If I lose my job and have to move to find a new job, I still have to use the \$100k from the savings account to pay off the mortgage, so… what’s the difference (aside from the interest rate arbitrage created by the difference between the mortgage rate and the savings rate)? Doesn’t this question more clearly address why someone would pre-pay a mortgage, but in a lump-sum sense instead of a monthly scrimp-and-save sense?”

88. financialwizardess says 19 March 2009 at 11:50

Of course, this logic assumes that you:
1) Do not plan to sell this house (we don’t – even if we lost our jobs, moving would not be an option)
2) Have no other debt (we don’t)
3) Are contributing to a retirement account to the max (we both max out our 401Ks and Roths)

In addition, we invest regularly in taxable accounts which someday might finance our kids education (still debating the merits of paying for that, but that’s another discussion…)

So in no way am I advocating forgoing retirement savings to pay the mortgage. First things first. This is funny money that I would otherwise add to our taxable investments (which I feel are already funded to the max of my risk tolerance).

I’ve toyed with the idea of just putting the extra \$ into CDs and then you have more flexibility and liquidity (somewhat). However this is where psychology comes in… I know myself, and if I had a pot of \$ sitting somewhere outside of a retirement account or brokerage account, I would feel a bit more entitled to a latte or another car or something. The “scarcity system” I have set up works best for me.

With that said, we find that in our situation we like the 30 year with optional prepayment.

We also take advantage of accumulating 1/2 the payment from our biweekly check in an interest bearing account which allows us to effectively make 13 payments/year.

89. Michele says 19 March 2009 at 12:27

The flexibility of prepaying principal in amounts that work for you month-to-month is far superior to me in terms of “sleep at night” value. Plus, if you’re the kind of person who needs the 15-year in order to force yourself to pay up, your lack of discipline probably means you have little extra cashflow anyway.

Our rate is just good enough that I can’t find a 1% improvement anywhere, which is the magic number I hear makes it worthwhile.

90. The Zombie Dr. says 19 March 2009 at 12:37

Shouldn’t you factor in the time value of money into all of this? IE Net Present Value.

91. Jadzia says 19 March 2009 at 13:08

JD, we did the exact same thing when we refi’d back in January. I had wanted to go with the 15-year and am now glad that hubby talked me out of it. We pay a flat \$2K as well. Yes, we come back a smidge behind if we had done the 15-year, but in this economy (and with 3 kids) the ability to drastically reduce our living expenses if something awful happens is more important.

92. Rachel says 19 March 2009 at 13:12

I would think that in most cases, for someone who is already not living “paycheck to paycheck” and on an accelerated mortgage repayment schedule, a 15-year mortgage is the way to go. If you have a safety net in the form of an emergency fund, then why the need for the lower monthly payment of a 30-year mortgage? I think most people, even financially responsible people, are so conditioned to think that 30-year mortgages are normal and “safe.” I used to think that too.

However, refinancing to a 15-year mortgage was key to helping my husband and I pay off our mortage much earlier than we ever dreamed of. (In just over 5 years!) Because of the way the loan was amortized, we could get at the principle SO much faster and this could become important to you and Kris if you ever decided to really step up your mortgage repayment schedule (say…\$3,000 a month). If you want to do that, run the numbers again to see if refinancing a second time makes sense. You might be surprised!

By the way, I would encourage you to take the extra money you are putting towards your mortgage each month and put it in your ING account instead. As long as you can keep your hands off of it, you are much better off keeping it in an interest-bearing account than you are sending it to the bank. Why? The loan amortization is already set. Unlike paying off a credit card, paying more money this month doesn’t mean you owe less interest the next month.

Worse yet, the bank cuts you no slack. If you sent them \$5,000 worth of extra payments and then came up short one month, that \$5,000 doesn’t help you at all. But if you sent the \$5,000 to your own savings account, you would have access to it.

Not only that, thanks to compound interest, your \$5,000 would now be worth more than \$5,000, and that’s just one more thing that will help you pay off your mortgage faster.

Good luck!

93. RP says 19 March 2009 at 13:28

By the way, I would encourage you to take the extra money you are putting towards your mortgage each month and put it in your ING account instead. As long as you can keep your hands off of it, you are much better off keeping it in an interest-bearing account than you are sending it to the bank. Why? The loan amortization is already set. Unlike paying off a credit card, paying more money this month doesn’t mean you owe less interest the next month.

Rachel, this is not true in general. With our mortgage, prepayments do decrease the amount of interest we pay going forward. That’s the way amortization works: you’re paying the interest on the current balance. Reduce the balance with prepayments, and the proportion of your payment that goes towards interest decreases.

I watch this every month in our online account, and verify that the interest/principal split is the same as in our amortization spreadsheet. It’s been identical (with a whole bunch of different prepayment amounts) for 6 years straight.

94. Jose says 19 March 2009 at 14:17

If the difference in interest rate between a 15 year and 30 year loan is 1/2 a percent. As an example, on a 150k loan, During the first year of the loan, the 30 year loan will cost you \$750 more than the 15 year loan. That is \$750 is your insurance premium in case you need to go to a lower payment. For some one who can *comfortablty* afford to make a larger payment each month that is an expensive insurance policy.

95. Darwin's Finance says 19 March 2009 at 14:56

It’s all about the Present Value of Money.

With rates this low and since the amortization has the majority of the initial payment toward interest, your effective interest rate post-deduction’s around 4%. Since a 4% hurdle rate is pretty conserative on any long term basis, you’re actually better off taking the longer amortization (30 years). You made the right move!

You can always make extra payments along the way, but if you go back a year or fast-forward a year, when the government cranks rates up to stave off inflation, you’ll find CDs yielding 5% easily. CD ladder into those and your excess cash is better off there than prematurely paying down the mortgage and incurring additional risk if you want to go down to one income.

I just did a piece on using Net Present Value calcs to decide between multiple mortgage options – this is a hot topic right now; I’m about to pull the trigger on mine!

96. One Frugal Girl says 19 March 2009 at 16:12

JD — Your situation is very interesting. My husband and I are currently paying down our mortgages so that we will be free and clear of house payments in the next 10-12 years. We refinanced from 30 to 15 on both of our homes and hope to be mortgage-free in our early 40s.

Of course, with mortgages out of the way we’ll have more freedom in our careers to work less, work in a more enjoyable position, etc. What’s interesting to me is that you are taking a less risky mortgage, but you are enjoying your time and career right now.

It’s an interesting spin on the decision and goes to show it’s not just about the numbers.

97. JoeTaxpayer says 19 March 2009 at 16:39

The fact that you did the math yourself and saw the numbers makes the choice you made the right choice for you.
It’s not as though you pulled more money out, you just left the flexibility so if you run into some period of bad income or expenses you can just make the actual payment. Tough to criticize that.
In my last refi, I had 18 left on a 20, and for a tiny bit more, dropped to 15, taking advantage of the lower rate. From there, I’ve made random prepayments to be done in about 12 years.

98. Kyle says 19 March 2009 at 17:20

@JD

“Plus, if we do pay the mortgage off early, there will tremendous peace of mind knowing that I have a great deal of flexibility.”

I’m not saying you aren’t planning for this (or that you’re making a bad decision), but technically you are reducing your flexibility by pre-paying your mortgage. When you pre-pay your mortage, the money you put into your home equity becomes much less liquid. You have to count on a bank (or credit union) re-loaning you the money again sometime in the future to get at it (or sell your house). If you keep it in the bank, you have the cash instantly available if needed.

Maybe you were referring to cash-flow flexibility. But having a pile of cash is just as good as having good cash flow.

Obviously, there are trade-offs to keeping the cash (such as dealing with low interest rates in savings accounts or risk in the stock market), but the trade-off to paying early is you lose the flexibility of more liquid investments.

Another aspect I’ve been thinking of recently is that a high-balance mortgage (within reason) is one of the best ways to protect against inflation. If inflation takes off in the coming years due to our economic conditions, the balance of the mortgage doesn’t go with it (and therefore depreciates while your house theoretically holds value).

99. Lea says 19 March 2009 at 19:38

If one considers only money to be riches, then the 15-year option is the best. However, I count security amongst my riches, and I’m doing exactly the same thing you are, for exactly the same reasons. If my husband’s employment situation continues to suck dead rocks, we will be able to get by on my salary alone. Here’s to comfort margins!

100. Attagirl says 19 March 2009 at 21:09

When I bought my home, I took out a 30 year mortgage because that’s what I could afford. I refinanced a few years ago with 22 years left and found I could get a 20 year loan – so I did. Even though I took money out (hey, I didn’t know any better at the time), my payment remained the same. And I paid off other debt, which I have never built back up. I pay extra, so I’ll have the 20 year loan paid off about 7 years early, so I think it’s working out well. Even though,looking back, I’d do some things differently, the mortgage is the only debt I have and it’s going down faster than I’d hoped. The 20 year was a good option for me. It’s all very individual.

101. azphx1972 says 20 March 2009 at 00:11

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.

102. Michael says 20 March 2009 at 00:40

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

103. Niall says 20 March 2009 at 06:06

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

104. JoeTaxpayer says 20 March 2009 at 07:34

“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.

105. brooke says 20 March 2009 at 08:03

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

106. Ian says 20 March 2009 at 08:25

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

107. Kris says 20 March 2009 at 11:36

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.

108. Rachel says 20 March 2009 at 13:10

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!

109. JoeTaxpayer says 20 March 2009 at 13:28

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.

110. Len Penzo says 20 March 2009 at 14:05

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

111. financialwizardess says 20 March 2009 at 14:20

@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.

112. XW says 22 March 2009 at 15:21

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.

113. JoeTaxpayer says 22 March 2009 at 19:02

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.

114. Weston says 23 March 2009 at 13:25

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.

115. RC says 23 March 2009 at 17:25

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

116. JoeTaxpayer says 23 March 2009 at 18:11

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.

117. RC says 23 March 2009 at 19:36

#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.

118. Joe Morgan says 24 March 2009 at 13:08

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!

119. Brian says 25 March 2009 at 14:25

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!

120. KAD says 01 April 2009 at 13:56

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…

121. Mike says 20 April 2009 at 13:26

@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.

122. JoeTaxpayer says 20 April 2009 at 14:03

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?

123. LaLaLand says 24 November 2009 at 22:50

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.

124. Jon says 18 May 2010 at 12:14

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?

125. Candee says 25 May 2010 at 17:17

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.