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15 vs. 30 Year Loan - Which is Better?
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The answer is not a simple one yet it's worth taking the time to understand as the results may surprise you
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Set Up and Compare Payments
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Total Cumulative payments made are shown here year by year along with the total payment savings realized with a 30 year loan:
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Total Principal Paid
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The perceived benefit of a 15 year loan is in the rapid principal reduction. In 15 years, you've paid back the entire loan vs. only a third of the balance on the 30 year loan option:
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Remaining Balances
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Net Cost Difference & Reason #1
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To calculate the "Net Cost Difference" we subtract the payment savings from the higher balance differential calculated earlier. The result is the actual higher cost of a 30 year loan vs. a 15:
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This is where most "conventional" analysis stops. Why would anyone that can afford it want a 30 year loan when they could have a lower rate and a shorter term with the 15? Let's take a look:
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Reason number 1 - Flexibility. The opportunity value of the lower monthly payment on a 30 year loan can be worth more than the benefit of a lower balance.
Imagine if you lost your income, would you survive longer on your emergency reserve savings with a higher or a lower mortgage payment?
So it's really not just flexibility but safety and liquidity. Although you would have a higher remaining loan balance, the accumulated payment savings from a 30 year
loan as you see above on the "Total Payment Savings" line can go a long way towards subsidizing your living expenses in the event of job loss, disability, other medical emergency,
large unexpected expense, etc.
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With a 15 year loan, you build up equity in your home, with a 30 year loan, you can build up your savings in an account where that money can be accessed without having to refinance or sell.
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Tax Savings & Reason #2
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Now, let's take it another step further
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For those that can afford a 15 year term, you are typically also in a higher tax bracket and as such, can derive a greater deduction on the interest that you pay. Since the rate on a thirty year loan is
higher and since you're paying interest on a higher remaining balance, so too will your total tax deductibility be higher.
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The Bottom Line & Reason #3
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Now, take the last step to see what happens when these savings are invested to earn a compounding rate of return. The advantage of a 30 Yr. loan can actually turn positive and that is reason #3:
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When the numbers above turn negative, that evidences that the 30 year loan is actually less expensive than the 15 - hard for some to believe, but it's really just math, the benefit of tax deductibility
and the magic of compound interest. I will of course be happy to walk you through how this works and to explore with you the best options for your preferences, peace of mind and suitability.
To make this visual, we'll use a graph and indicate the 15 year loan as the baseline (zero). We'll then impose the real cost difference of the 30 against it.
The point at which you cross under the zero baseline is the point at which the 30 is more advantageous than the 15.This will vary with the interest differential, the investment rate selected and your tax bracket.
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If the blue line crosses under the red line, this shows the point at which the true cost of a 30 year loan is actually less than a 15
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Use the slide controls to see how changes in the investment yield and your tax bracket will influence the results
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