15 vs. 30 Year Mortgage: The Surprising Better Deal

This is a guest post by Andy Lindeman.

Laura and I recently bought a condo together, and one of the many decisions we needed to make was the type of mortgage to get. We knew we wanted a fixed rate mortgage, but we needed to choose a term: the most popular options are 15 years and 30 years.

Well, I’m an engineer so I make decisions with numbers! For an example in this post, I’m going to consider a $250,000 home with a 20% downpayment (avoiding the need to calculate PMI) and with current interest rates from bankrate.com as of 2 October 2014. I used Zillow’s mortgage calculator to compute monthly payments.

15 year	3.44%	$1,424/month	$256,320 paid over loan lifetime
30 year	4.27%	$986/month	$354,960 paid over loan lifetime

The differences seem pretty stark: the 15 year mortgage has a higher monthly rate, but is offered at a lower rate that saves nearly $100,000 over the lifetime of the loan.

Except it’s not valid to compare those numbers.

Consider a case where you spot me $10 for lunch because I forgot my wallet. If I pay you back tomorrow, the $10 will have the same purchasing power as it did yesterday. If $10 bought a lunch yesterday, it will buy the same lunch today. But if I wait 10 years or longer to pay you back, it’s very likely that lunch at the same diner will cost closer to $15 or more because of inflation.

Applied to the example above, the monthly payments a homeowner makes today have more purchasing power than the monthly payments the homeowner will make 10, 20, or 30 years down the line. A monthly payment of $986 or $1,424 will likely hit their pocketbook harder today than it will decades from now.

It’s relatively easy to adjust the “loan lifetime” numbers for inflation by calculating them in terms of present value. I used a spreadsheet to apply the formula here to each monthly payment over the lifetime of the loan.

Unfortunately we need to guess at what inflation will look like over the next 30 years, and that’s a subjective decision. I’ve given a range of possibilies in the table below:

</table> Now it's more clear how much inflation affects homeowners with mortgages. At 2% inflation, the 30 year mortgage costs about $46,000 more in today's dollars than the 15 year mortgage. It's valid to compare these numbers directly. $46,000 in 2014 dollars is a chunk of change! If inflation stays as low as 2%, homeowners who choose the 15 year loan and are able to make the higher monthly payments come out ahead of homeowners who chose the 30 year option. But things get interesting toward the other end of the spectrum. At 6%, homeowners who choose the 30 year loan come out marginally ahead of those who choose the 15 year mortgage. How can that be? Well, if inflation creeps up and stays at 6%, having a loan where the rate is lower than inflation is a big win: in some senses, homeowners who have a loan whose interest rate is lower than the inflation rate pocket the difference as time goes on. What will be the reality? It's obviously unclear. For the past few years, [inflation has been very low](http://www.usinflationcalculator.com/inflation/historical-inflation-rates/). But historically there have been periods where it's been much higher, even higher than 6%. It's also worth noting that inflation rates will vary over the course of the loan too rather than staying constant as I assumed for the example above. Whatever the reality ends up being, if inflation stays positive, the gap between a 15 year mortgage and 30 year mortgage over their lifetimes shrinks from the difference between simply adding their monthly payments up. In general, I think it's good to consider this because you might want to use the difference in monthly payments to do other things that enrich your life: invest in a crazy idea, take another vacation, create an emergency fund, etc. If you know that the actual difference (after inflation) is much lower than the pre-inflation numbers, it might be easier to justify in your mind. Laura and I eventually chose a 30 year mortgage, though the reasons go beyond present value. I plan to write another post in this series explaining our rationale that I'll link here after it's posted.

Loan Term	0% Inflation	2% Inflation	4% Inflation	6% Inflation
15 year	$256,320	$221,940	$194,082	$171,309
30 year	$354,960	$267,857	$209,006	$168,111