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
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
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
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
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
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
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
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
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
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
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.