Monday, July 28, 1997
Fifteen- or Thirty-Year
Mortgage?
by
[email protected]
Whenever you apply for a mortgage, whether it's for a new purchase or to refinance an existing mortgage, the question (and debate) comes up: should you go with a 15-year or a 30-year mortgage? (This presumes, of course, that you can afford the higher payments of a 15-year loan.) There are good arguments for each side. In a nutshell they are:
--Take a 15-year, because you save a lot of money in the long run.
--Take a 30-year, because you have more flexibility in the payments.
$100,000 loan, 30 years, 8.0% = $733.77 per month.
$100,000 loan, 15 years, 7.5% = $927.02 per month.
You will save a grand total of $97,294 with the 15-year loan.
This assumes that your only option is to "invest" the extra payment money ($192.25 per month) into your mortgage. But Fools realize that they have other options. Suppose you invest this money with one of the Unemotional Value strategies, and earn the historical long-term average growth rate (CAGR) of 23% (UV2) or 21% (UV4+). Further assume that you have 100% annual portfolio turnover, so you pay the full capital gains tax of 20% each and every year. If you can afford $927.02, you can take the 30-year loan, and each month pay the $733.77 loan payment and invest $192.25 (the difference between the two payments) into a UV portfolio. Your investment grows while the loan balance shrinks. Eventually, the investment account will match the loan balance, and you can pay off the loan early.
With UV2 this will be at 11 years and 3 months. With UV4+ this will be at 11 years and 10 months.
But what if you continue this for the full 15 years? You will still owe $76,779 on the mortgage. However a UV2 account will be worth $181,454, or an extra $104,675. A UV4+ account will be worth $153,982, or an extra $77,203.
But you might not get the average return; you might be unlucky and hit a stretch of below-average UV returns. For the years from 1961 to 1997, the worst 15-year period had overall returns of 17.3% (UV2) and 15.1% (UV4+). Even if you hit this historically worst period, you would still be able to pay off the mortgage early: 13 years and 0 months for UV2, or 13 years and 9 months for UV4+. In other words, there's more to this debate than a simple choice. Check out your Foolish options.