30 year loan or 15 year loan. Which is better?

Here 30 year or 15 year loans mean 30 year or 15 year fixed rate mortgage as these are 2 most popular residential mortgage loan products.

Assume a typical loan of $200,000 for a purchase price of $250,000. That is an 80% loan or say the borrower paid the 20% down. Assume the borrower has A+ credit score, good income, enough assets to satisfy the lender underwriting guideline. He/she qualify both 15 and 30 year mortgage. As current market November 7, 2012, we can offer 3.125% rate for 30 year fixed rate term and 2.5% rate for 15 year with the same origination fee. Use these two rates for below home work. Using any online mortgage calculator, you can calculate monthly payment. For a $200,000 loan with 3.125% rate and 30 year term, the minimum monthly payment (principal and interest) will be $856.75 and total payment the loan will be $308,430.53 in next 30 years. Assume the borrower do not pay any extra, do not pay any late. If the loan is a 15 year fixed rate term, with the same closing cost, interest rate can be 2.5%. I use an mortgage calculator to get $1333.58 monthly payment. Total payment in next 15 year will be $240,044.01. Compare last 2 results, looks the 15 year save a lot money. Total $308,430.53 – $240,044.01 = $68386.52. If you look at the interest paid every year, you can find first year the 30 year term need $6191.75 for 30 year term and $4873.04 for 15 year term. The interest different for the first year of the loan is $1318.71. Looks 15 year term is saving money. Right? Let’s see below opinion. As the borrower can afford the 15 year term that will have $1333.58 – $856.75 = $476.83, we use 30 year term mortgage and put that $476.83 to an investment like bond, mutual fund, annuity, some kind of life insurance. Assume different investment return that we can see result. Assume investment return is 5% annually, the 15 year $476.83 monthly investment will have $127982.54 in end of 15 year. The mortgage amortization table can help us to see for a 30 year mortgage will have principal balance after 15 year as $122,988.91. So if you use the investment return to payoff the mortgage then, you will have $127982.54 – $122,988.91 = $4993.63. Here we did not count tax result and inflation. Actually most people can get tax benefit for mortgage interest payment and need to pay tax for investment return. The result can be different and complex. The inflation will make future money less value. The main idea is if you know an investment that return better than 5%, the 30 year is likely to be better than the 15 year return.

 

In last 15 years, S&P average yearly return is about 7.1% per year. So if you invest in S&P 500 index fund. 30 year mortgage is better than 15 year. If you invest $476.83 each month with average 7.1% yearly return. The 15 year after, total asset should be $149556.54. So you can use that money payoff mortgage left $122,988.91 and still have $26,567 left.

 

I did other articles that real estate investment can have return above 20% per year. I leave how much you will be after 15 years if your investment return is about 20%.

 

If you interested to have more investment with loans, you need to qualify multi loans from lenders, the debt to income ratio is very important when approve a loan. Even when you file tax return, a 15 year loan will makes your profit higher but cash flow lower. The lenders use cash flow (not your profit/loss) to calculate your debt to income ratio. So 15 year loan will makes your debt to income ratio higher that will makes your next loan harder to be approved.

 

Cash flow is also important in hard time. When economy down turn, rent may be lower, your normal income may be lost. If you do not have cash flow, you will have higher risk of lost the investment when you can not make monthly mortgage, tax, insurance, HOA payment. Usually the housing price is low during such down turn. From history we know in most most cases, as time going, the house price will recover. You need be able to prevent selling the house or foreclosure in downturn time. Keep a better cash flow will be safer.

 

Above is my personal opinion and not investment advice. For your reference only, if you interested in topic of real estate investment, join my linkedin: https://www.linkedin.com/in/james-wu-53583228/ and join my group: https://www.linkedin.com/groups/12026009.

 

Or contact me by text me at (512) 785-3841.