If you cannot afford the monthly payment on a 15-year loan, your choice is made for you. If you can afford the 15, you must decide whether you are a payment-mini-mizer or wealth-maximizer. The first group is concerned mainly with the present, the second with the future.
The mortgage payment on a $100,000 30-year loan at 7% is $665 while on a 15-year loan at 6.75% it is $885. The payment minimizer is drawn to the lower payment on the 30.
On the other hand, after 5 years the borrower who took out the 15-year loan has repaid $22,933 while the borrower who took out the 30 has repaid only $5,868. That amounts to a difference in wealth accumulation of $17,065. To me, that's even more attractive; I'm a wealth-maximizer.
Some borrowers who can afford the 15 opt for the 30 because of the flexibility it provides. You can make the larger payment of the 15, they argue, but you don't have to; if you get into a pinch, you can make the lower payment of the 30. Those who take a 30 but make the larger payment of the 15, however, don't pay down the balance as rapidly as they would have if they had taken a 15 because they are paying the higher rate of the 30.
I have found that many borrowers who elect the 30-year option to obtain flexibility subsequently find that they really don't want it after all! After a few years of being homeowners, they discover that what they really want is to build equity more quickly than the 30 allows. They discover, in other words, that they want to build wealth.
At that point some of those who took out 30-year loans begin systematically making additional monthly payments in order to build equity faster. Of course, they would have been better off taking the 15-year at the outset and enjoying the lower interest rate, but better late than never.
If the rates on the 30 and 15 are 7% and 6.75%, for example, a 10% investment yield would not put you ahead for 63 months. At investment yields of 12%, 14%, and 16%, the periods are 41, 30 and 24 months, respectively. If the rate on the 15 is 6.5%, the periods are almost twice as long.
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