The 15 Year Mortgage Debunked.
Updated: May 5, 2020
Although a large number of financial professionals, such as Dave Ramsey, preach about the necessity of buying your home on a 15-year mortgage, I am here to tell you otherwise. To first understand the difference between the two, let us weigh the pros and cons. At first glance, it might seem like the 15-year mortgage is the superior option because you will pay less on interest. However, as we look deeper, the additional cash flow of the 30-year mortgage, if placed the right investment, will improve the homeowner's net worth.
Example Of Both
In this example, we will have 2 people, Emily, a person who purchases the 15-year mortgage, and Cameron, who will buy the 30-year mortgage. Each person will purchase a loan worth $300,000 at a 5% interest rate. Because Emily purchased the 15-year loan, she will have a monthly payment of $2,372.38. After 15 years, Emily will then invest the same $2,372.28 for the next 15 years at an 8% return until her thirty years is complete. On the other hand, since Cameron bought the 30-year mortgage, he makes his monthly payment of $1,610.46 and then invests the extra $761.92 for the entire 30 years at an 8% return (We get the $761.92 by taking $2,372.28-$1,610.46). Overall, both individuals will be putting $2,372.28 into their house and/or an investment for 30 years. After the thirty years is complete, Emily will have paid off her house and will have an investment portfolio worth $773,825. For Cameron, after 30 years, he will have paid off his house and will have an investment portfolio worth $1,037,328. Because Cameron paid his loan over 30 years and invested his capital elsewhere, Cameron ended up having an investment portfolio worth $263,503 more.
Overall, if you have the decision between a 30-year loan and a 15-year loan, the 30-year loan will be superior if and only if you invest your capital elsewhere, this is stating you get the average market returns of 8%. With this information, you will be able to have an additional $263,503 in your pocket. Just think for a second on what you could do with this extra cash. You could pay for your kid's college, retire early, or buy a larger house.
Disclaimer: I am not a financial advisor, so please review all of this advice with your CFP or financial advisor first.