Low Rates Lure Homeowners to 15-Year Mortgages

With interest rates low, more homeowners are opting for 15-year fixed-rate mortgages over the traditional 30-year loan term, both for new purchases and to refinance existing loans.

Although the monthly payments are higher, buyers can save tens of thousands of dollars in overall interest costs, plus own their homes free and clear in half the usual time. Also, 15-year mortgages typically carry lower interest rates--up to half a point lower.

In California, where home prices on average are among the highest in the country, the monthly payment on a 15-year mortgage might be too costly for many home buyers. However, those refinancing an existing home loan should certainly look at the 15-year option, said Earl Peattie, publisher of Mortgage News. One of the first things homeowners should do when refinancing is determine whether they can get a 15-year loan, he said.

While that’s mighty appealing, some financial experts argue that it may not be the best route, even for those who can easily afford an accelerated payback.

“Many home buyers . . . would be much better off taking the lower 30-year payment and investing the difference in a tax-deferred investment plan,” such as an employer-sponsored 401(k) plan or an individual retirement account, concluded a study in the April edition of the Journal of Financial Planning, trade publication of the Institute of Certified Financial Planners.

The study, conducted by Delbert C. Goff and Don R. Cox, professors from Appalachian State University in Boone, N.C., analyzed a $150,000 mortgage for a borrower in the 33% combined federal and state tax bracket. The borrower has to choose between a 15-year mortgage at 7.5% and a 30-year loan at 8%. (Current market rates are actually lower--around 6.8% and 7.2%, respectively.)

Under the 15-year mortgage scenario, the borrower begins a savings plan only after the mortgage is paid off, then invests the entire mortgage payment in a tax-deferred retirement plan earning 10% a year for 15 years.

The borrower with a 30-year loan, on the other hand, immediately invests in a retirement plan, also yielding 10%, the monthly difference between the higher payments of the 15-year mortgage and the lower payments of the 30-year loan.

(The monthly payment on the 15-year loan amounts to $1,390.52, or $16,686 annually, excluding property taxes and insurance, and on the 30-year, $1,100.66, or $13,208 annually.)

The study found that, under that scenario, the homeowner with the 30-year mortgage would build a retirement account of $1.17 million vs. $791,000 for the owner paying off the mortgage in 15 years.

While most financial experts agree that the plan works well in theory, some question whether it can be carried out by average homeowners.

“It assumes the borrower will have the discipline to set aside monthly savings and invest each month. Look at the dismal savings rate for the U.S. versus other countries,” said Peter G. Miller, a Washington, D.C., author of several consumer real estate books. “The assumption is also that investing each month will yield a higher rate of return than investing in your mortgage.”

Jonathan Pond, a Boston-based financial planner, agreed: “The assumption is that all of your money is put into stocks. But most people prefer to have both high- and lower-risk investments, which include bonds, which have a lower rate of return.”

Pond, however, thinks borrowers would be better off in the long run contributing to a retirement plan than making an extra mortgage payment. If they can do both, all the better.

“It’s a wonderful feeling, paying off a mortgage early,” he said.

One rule of thumb for determining whether to go for a 15-year versus a 30-year loan: “Do not take a 15-year out in lieu of a 30-year if you can’t comfortably max out on a retirement savings plan,” and make the maximum contributions allowed by an employer.