Yeah, I said it! If you choose a 30-year mortgage as opposed to a 15-year, you are stupid! I don’t mean that as an insult necessarily. I say “stupid,” meaning that you either can’t do math or you just don’t care enough to pay attention. Also, I am allowed to call others stupid because I too have been stupid in the past. When you take a look at the numbers I am about to present, you will plainly see the absolute stupidity of the 30-year home mortgage.
A Decade of Falling Home Mortgage Interest Loan Rates
For my following example, I chose the year 2002 because that is the year I bought the home I currently live in. At the time, interest rates were hovering down around 7%, which were all-time lows for my lifetime. People were ecstatic about the low rates and the home refinance craze was in full swing. In fact, rates kept dropping drastically and I myself refinanced three times withing the first two years of owning my home. I settled on a 25-year loan at 5.375% in 2004. I was certain that I would never see lower rates in my lifetime.
Fast forward to the fall of 2010 and home mortgage interest rates had dropped to around 4%. In December of that year I was able to close on a 15-year refinance at 3.75%! Again, I was absolutely positive that I would never see lower interest rates in my lifetime. Well, it is now 2012 and rates have dropped ever so slightly. 30-year mortgages are now going for under 4% and 15-year mortgages are hovering around 3%. In my following example, a 2012 payment on a 3% 15-year loan is actually less than a 2002 payment on a 7.5% 30-year loan! In other words, you can pay less per month now on a 15-year home loan than you could ten years ago on a 30-year home loan.
*Monthly Payment is the minimum payment and does not include escrow amounts (for taxes, insurance, etc.)
*Total Interest Paid assumes minimum monthly payments are made for the entire duration of the loan.
All calculations done on calculators provided at Bankrate.com
Analyzing the Amortization Table for each $150,000 loan
The 2002 30-year loan at 7.5% has a minimum monthly payment of $1048.82. If you look at an amortization schedule for this loan, you will find that only $111.32 of your first months payment gets applied to the principal balance. The remaining $937.50 for that month is all interest that the bank receives. If you pay only the minimum payments, it will be more than 20 years before your principal portion of your monthly payment becomes greater than your interest portion!
The 2012 30-year loan at 3.75% is incredible compared to the same loan from only 10 years prior. The interest rate is half and the minimum monthly payment is only $694.67. The principal to interest paid ratio for the first month is not nearly as bad as the 7.5% loan. For the first month of this loan, $225.92 is applied to principal, while $468.75 goes to the bank in interest. Again, assuming only minimum monthly payments are made, it will be just over 11 years before the principal portion of the monthly payment becomes greater than the interest portion.
The 2012 15-year loan at 3.0% is by far the best option of these three loans. Interest rates are at all-time lows. 3% is absolutely unheard of for a mortgage loan! The minimum monthly payment for this loan is $1035.87, which is slightly lower than a typical 30-year payment from only 10 years ago! Yes, it is about $340 higher than the 2012 30-year payment in this example. But, check out the principal to interest paid ration for the first month! $660.87 gets applied to principal in the first month while then bank gets only $375 in interest. That’s right, zero months before your principal portion of your payment becomes greater than your interest portion.
A Perspective from Another Angle
Think of your income as your most valuable asset. In most cases, it is! When you take on payments, you are tying up your most valuable asset. The larger the payment, the less wiggle room you will have. A longer term on a loan means less time that you will have access to your most valuable asset. Say the average person works from age 20 to age 65, or 45 years. If you commit to paying a huge mortgage payment for 30 years, that is two-thirds of your working lifetime! By sticking with a 15-year mortgage, you will only be tying up that huge portion of your income for one-third of your career.
Compare your income to the most valuable player on a sports team. Let’s use hockey as an example. Wayne Gretzky was a pretty good asset to the teams he played for. You wouldn’t want him stuck in the penalty box for two out of three periods in a game. That is essentially what you are doing to your income when you take on a 30-year mortgage. If you had to choose, you would prefer that Wayne Gretzky spend only one entire period in the penalty box. This equates to one-third of the game, which compares to the 15-year mortgage during the 45-year working lifetime. Obviously, the best option would be to let Wayne Gretzky play the entire game, which would be the same as paying cash for a house and having no payments. Unfortunately, not every team can have Wayne Gretzky and let him play the entire game. Likewise, not everybody can pay cash for a house within their working lifetimes.
Dismantling One Other Myth
Many people who take on a 30-year mortgage justify their decision by saying that they will pay it like a 15-year and will essentially yield similar financial results. The thought here is that they will have the freedom to pay the lower payment if need be, but will only do so in tough financial times. I am here to say, no you won’t! If the option is there, you will end up paying minimum payments. You might pay extra for awhile, as planned, but then life will happen. Life never goes exactly as planned. If you have a minimum payment based on a 30-year mortgage, that is what you will base your future budgets around. You don’t want that option. Stick with the 15-year, even if it hurts a little financially at first. Force yourself to pay that much less interest to the bank. Don’t leave yourself the option of financing some giant monster mega bank’s huge downtown skyscraper. Don’t commit to handing over a huge portion of your most valuable asset for two-thirds of your working life. Don’t put Wayne Gretzky in the penalty box for two entire periods!
Readers: Tell me your thoughts on this topic. Do you know anybody who has actually paid off a 30-year mortgage in less time? Do you think my advice is reasonable?
A Decade of Falling Home Mortgage Interest Loan Rates
For my following example, I chose the year 2002 because that is the year I bought the home I currently live in. At the time, interest rates were hovering down around 7%, which were all-time lows for my lifetime. People were ecstatic about the low rates and the home refinance craze was in full swing. In fact, rates kept dropping drastically and I myself refinanced three times withing the first two years of owning my home. I settled on a 25-year loan at 5.375% in 2004. I was certain that I would never see lower rates in my lifetime.
Fast forward to the fall of 2010 and home mortgage interest rates had dropped to around 4%. In December of that year I was able to close on a 15-year refinance at 3.75%! Again, I was absolutely positive that I would never see lower interest rates in my lifetime. Well, it is now 2012 and rates have dropped ever so slightly. 30-year mortgages are now going for under 4% and 15-year mortgages are hovering around 3%. In my following example, a 2012 payment on a 3% 15-year loan is actually less than a 2002 payment on a 7.5% 30-year loan! In other words, you can pay less per month now on a 15-year home loan than you could ten years ago on a 30-year home loan.
$150,000 Mortgage Comparison
Year | 2002 | 2012 | 2012 |
Loan Term | 30 years | 30 years | 15 years |
APR | 7.5% | 3.75% | 3.0% |
Monthly Payment* | $1048.82 | $694.67 | $1035.87 |
Total Interest Paid* | $227,575.83 | $100,082.42 | $36,457.04 |
*Monthly Payment is the minimum payment and does not include escrow amounts (for taxes, insurance, etc.)
*Total Interest Paid assumes minimum monthly payments are made for the entire duration of the loan.
All calculations done on calculators provided at Bankrate.com
Analyzing the Amortization Table for each $150,000 loan
The 2002 30-year loan at 7.5% has a minimum monthly payment of $1048.82. If you look at an amortization schedule for this loan, you will find that only $111.32 of your first months payment gets applied to the principal balance. The remaining $937.50 for that month is all interest that the bank receives. If you pay only the minimum payments, it will be more than 20 years before your principal portion of your monthly payment becomes greater than your interest portion!
The 2012 30-year loan at 3.75% is incredible compared to the same loan from only 10 years prior. The interest rate is half and the minimum monthly payment is only $694.67. The principal to interest paid ratio for the first month is not nearly as bad as the 7.5% loan. For the first month of this loan, $225.92 is applied to principal, while $468.75 goes to the bank in interest. Again, assuming only minimum monthly payments are made, it will be just over 11 years before the principal portion of the monthly payment becomes greater than the interest portion.
The 2012 15-year loan at 3.0% is by far the best option of these three loans. Interest rates are at all-time lows. 3% is absolutely unheard of for a mortgage loan! The minimum monthly payment for this loan is $1035.87, which is slightly lower than a typical 30-year payment from only 10 years ago! Yes, it is about $340 higher than the 2012 30-year payment in this example. But, check out the principal to interest paid ration for the first month! $660.87 gets applied to principal in the first month while then bank gets only $375 in interest. That’s right, zero months before your principal portion of your payment becomes greater than your interest portion.
A Perspective from Another Angle
Think of your income as your most valuable asset. In most cases, it is! When you take on payments, you are tying up your most valuable asset. The larger the payment, the less wiggle room you will have. A longer term on a loan means less time that you will have access to your most valuable asset. Say the average person works from age 20 to age 65, or 45 years. If you commit to paying a huge mortgage payment for 30 years, that is two-thirds of your working lifetime! By sticking with a 15-year mortgage, you will only be tying up that huge portion of your income for one-third of your career.
Compare your income to the most valuable player on a sports team. Let’s use hockey as an example. Wayne Gretzky was a pretty good asset to the teams he played for. You wouldn’t want him stuck in the penalty box for two out of three periods in a game. That is essentially what you are doing to your income when you take on a 30-year mortgage. If you had to choose, you would prefer that Wayne Gretzky spend only one entire period in the penalty box. This equates to one-third of the game, which compares to the 15-year mortgage during the 45-year working lifetime. Obviously, the best option would be to let Wayne Gretzky play the entire game, which would be the same as paying cash for a house and having no payments. Unfortunately, not every team can have Wayne Gretzky and let him play the entire game. Likewise, not everybody can pay cash for a house within their working lifetimes.
Dismantling One Other Myth
Many people who take on a 30-year mortgage justify their decision by saying that they will pay it like a 15-year and will essentially yield similar financial results. The thought here is that they will have the freedom to pay the lower payment if need be, but will only do so in tough financial times. I am here to say, no you won’t! If the option is there, you will end up paying minimum payments. You might pay extra for awhile, as planned, but then life will happen. Life never goes exactly as planned. If you have a minimum payment based on a 30-year mortgage, that is what you will base your future budgets around. You don’t want that option. Stick with the 15-year, even if it hurts a little financially at first. Force yourself to pay that much less interest to the bank. Don’t leave yourself the option of financing some giant monster mega bank’s huge downtown skyscraper. Don’t commit to handing over a huge portion of your most valuable asset for two-thirds of your working life. Don’t put Wayne Gretzky in the penalty box for two entire periods!
Readers: Tell me your thoughts on this topic. Do you know anybody who has actually paid off a 30-year mortgage in less time? Do you think my advice is reasonable?
