Are We Still Having The 15 vs. 30 Year Mortgage Debate?

Do you guys know what rhymes with debate? Masturbate. HEY. I NEVER CLAIMED TO BE MATURE.

Anyway, I know that literally every other blogger in history has done this post. I’m altogether too lazy to check back to confirm this, so you’ll just have to take my word for it. Why do I think I have something extra to add to this already overwrought  debate? Well, first off, I GUARANTEE my post will contain more penis jokes than all those other ones. Besides, I’m 92% smarter and 104% more attractive than all the others who have previously tackled this. And 394% more humble. It’s a very complicated formula. I wouldn’t attempt it.

Anyhoo, back to the debate. Us Canucks don’t typically have 30 year mortgages, 25 year loans are much more common. Some people are ambitious and take 15 year mortgages, but a 20 year mortgage is the norm for people who are trying to more aggressively pay down their debt. Once we get to the end of the post though, you’ll see how the numbers work even for Canadian mortgages. That’s a bigger tease than the cover of Hustler magazine. (I buy it for the articles)

Let’s run some hypotheticals, bitches!

Purchase price: $300,000
Interest Rate: 4%
30 year mortgage payment: $1426
15 year mortgage payment: $2214
Total interest paid 15 year: $98,540
Total interest paid 30 year: $213,560

It’s official, the 15 year wins, right? Over those extra 15 years, you’d save an extra $115,020 in interest if you’d just stop being a slacker and pay off your place quicker. Of course, you won’t be able to afford as much house to begin with if you do take out a 15 year loan, but that’s okay. How many people do you know who live in place that’s way the hell too big anyway? Many of us could easily downsize to a smaller place.

But wait. Let’s assume that our imaginary home buyer can afford both the 30 year and 15 year mortgages. He’s raking in the cash, probably doing boob jobs for that Heidi chick from The Hills. It becomes a choice of preference, rather than necessity. Let’s also assume, just for this example, that if he takes the 15 year mortgage, our hypothetical buyer isn’t going to have much room left over to contribute to his future. Our hypothetical buyer is also a guy, because boys rule and girls drool, at least according to that 6 year old I just talked to.

But, that’s okay, because he’ll have a paid off house, right? That’s true, but that’s all he’ll have, since Mr. Hypothetical is putting all his cash towards his house. We won’t look at whether his house goes up in value or not, because our other hypothetical buyer will also see their house go up in value. We’ll pretend hypothetical buyer B is a girl, to save some grace with my dwindling female readership.

Buyer A pours all his cash into his house, so for 15 years he doesn’t invest an extra dime. But, from year 15 to year 30 he’s going to have all sorts of money to invest – $2214 per month to be exact. After 15 years of investing $2214 per month at an 8% return, hypothetical buyer A ends up with a nest egg of $779,087. He also ends up with a fully paid for house. Assuming he bought the place when he was 30, he’s not sitting bad as a 60 year old. Well done, hypothetical buyer A. Your grandkids will undoubtedly squander your inheritance.

Back to buyer B. She takes the 30 year mortgage, along with the $1426 monthly payment. Every month, she’s got an extra $788 compared to our other buyer. She thinks about going out and spending it on shoes, makeup, clothes and whatnot, but that would be silly. So she invests it in her brokerage account, and uses glimpses of cleavage to get guys to buy her those things. Like our other buyer, she gets an 8% return, but she manages to maintain her’s over a 30 year period.

After her extended mortgage is over, she has investments worth $1.157M. She’s got our first buyer beat, and beat handily. She will leave a much larger estate for her grandkids to squander. How does she end up with so much more than the first guy? Compound interest, stupid.

Compound interest works really well when you start early. By the time the first buyer even begins to invest, buyer B has over $277,000 already invested. It would appear that he gains ground as time goes on, but buyer B just has too much of a head start. Besides, after the mortgage is paid off, buyer B can afford to invest just as much as buyer A.

Americans can deduct their mortgage interest, meaning the extra interest buyer B pays over the life of her loan is mitigated. Canadians can’t deduct their mortgage interest, but interest rates are so low right now that maintaining a mortgage and investing at the same time is a form of leveraging. Mortgage debt is typically the best way for people to borrow money, since the bank has built in collateral, and because most mortgages in Canada are insured by the federal government.

With Canadians, this exercise gets a little more complicated, because we renew our mortgages, usually every 5 years, and there’s no guarantee that we’ll get attractive mortgage rates when we do. Generally too, the 5 year fixed mortgage rate up here is about equal to the rate of return you can get from a basket of low risk debt.

Once you even out the results over 25 or 30 years though, the return on equities will be higher than the return on fixed income. That’s just the nature of investing. Since equities are prone to knee-jerk reactions sometimes, they will have higher rates of return over time. That’s the nature between risk and reward. Long term investors are rewarded for taking additional risk. Short term investors are not, which is why they shouldn’t be taking said risk.

If you are one of those people who feels the need to pay off the mortgage quicker, might I suggest an alternative? Take out the 30 year loan, and make sure you get a mortgage that allows you to make prepayments of 20% per year without a penalty. Then you can make your small mortgage payments, save up some cash on the side, and then put big chunks down directly on principal. You’ll save interest, plus this strategy give you extra flexibility.

Also, a longer amortization is ideal because of inflation. As time goes on, a $1426 mortgage payment is worth less and less in real terms. Inflation slowly eats away at the value of the payment, meaning each payment gets just a little bit more affordable. Well, assuming your salary also moves up with inflation.

Now that I’ve straightened this up, you’ll have to excuse me. I’m off to stand outside the window of the house buyer B bought. Has anyone seen my binoculars?

Be Sociable, Share!

•