15 year versus 30 year mortgage

Since I was recently house shopping I have decided to share my thoughts on mortgages. I am not a fan of adjustable rate or interest-only mortgages as they tend to only cause financial trouble or even crisis later on. I only support fixed rate, fixed term mortgages and that is what I have on my foreclosure that I just bought.

When I was looking at houses I decided that a 30 year mortgage was best for me. I am over 30 years away from retirement, have a lower payment, and can always add principal payments if I desire. I like the flexibility. Having the lower payment allows me to tackle higher interest bad debts and get them gone faster. I end up saving in the long term.

If you are house shopping and no longer have bad debts (credit card, auto loans, etc.) I would suggest a 15 year mortgage if you can afford it. You will save a small fortune in interest in the long term and the monthly payment goes away a lot faster. You should absolutely get a 15 year mortgage if you are 20 years or less away from your target retirement age. The ideal situation is to have the house paid for by the day you retire at the latest.

That said, their are exceptions to the above rules. If I knew that I would be selling the house in a few years after I bought it or going to use it as a rental property after I moved out then I would do a 30-year mortgage. The tax breaks and more positive cash flow from a rental make sense in this case. If your cash flow becomes exceptionally good you can always accelerate the payments on principal.

The best way to pick the term of your mortgage is to take a close look at your personal financial situation. Ask yourself these questions:

  • Would I save more in interest by taking a 30 year term and paying down other debts?
  • How much of a monthly mortgage payment can I afford?
  • When is my target retirement date and how close am I to that date?
  • When do I plan to sell the house (if at all!)?
  • Am I going to need to borrow money to do remodel or repairs on the house as well?
  • What are the tax, insurance, and maintenance costs each month?
You should also consider your tax bracket and tax breaks from the interest. This is only a secondary concern but does changes the numbers a bit. It is best to avoid paying interest when you can but sometimes it can make sense to pay more interest and refinance later if rates are expected to drop. If you fall into a 20% marginal tax rate, for example, you can reduce the total interest on the loan by 20% as you would save that money on your income taxes assuming you itemize deductions.

One final item to consider and should really not affect your decision at all is future borrowing potential. Having a higher payment from a 15 year mortgage could theoretically drop your ability to borrow for other needs as you have less disposable income. This should be a non-issue for most as we should save for things and not borrow.

Buying a house is a big investment and it is important to make the right mortgage choice for your situation. If you have covered all of the above items then you have "done your homework" and are on the right path. Now that you have figured out your mortgage details and how much you can afford go out and find your new home!