When applying for a mortgage, one of the most consequential decisions homebuyers make is choosing the term of their loan. While most buyers opt for a 30-year mortgage, a small percentage purchase their home using a 15-year mortgage because of the long-term savings a shorter duration loan offers.
Despite higher monthly payments, a 15-year mortgage results in less interest paid over the term of the loan. This potentially saves homebuyers tens of thousands, if not hundreds of thousands of dollars, making it the more prudent option.
But what about homebuyers who want to continue investing in the stock market while also making their monthly mortgage payments? While a 30-year fixed mortgage will free up more cash to invest each month, that doesn’t make it the better option. Below we’ll show you why a 15-year mortgage can be a better long-term financial move if you can afford the higher monthly payment.
Still not sure which route is best for your specific situation? A financial advisor can help you decide which loan term is best for your individual situation and long-term financial goals.
Parameters of Our Analysis
Before we delve into our comparison between a 15- and 30-year mortgage, it’s important to note some of the assumptions we made. First, we based our calculations on the purchase of a $500,000 home with a 20% down payment ($100,000). Using Freddie Mac data, we also compiled the average interest rates for 30- and 15-year mortgages as of June 23, 2022 (5.81% and 4.92%, respectively) and calculated the monthly payments for each ($2,350 and $3,147, respectively).
Next, we assumed our hypothetical homebuyer Monica has $3,147 in her monthly budget for housing. Why $3,147? Because that’s how large a monthly mortgage payment would be for a $400,000 home loan on a 15-year mortgage.
The long-term growth of Monica’s investment portfolio is another important component of our analysis. After paying off her 15-year mortgage, we assumed she would begin investing her full monthly housing budget in the stock market and have an average annual return of 7% over the next 15 years, slightly less than the S&P 500’s historical average.
But since the 30-year mortgage comes with lower monthly payments stretched out over 30 years, we calculated how much Monica would stand to make if she invested the difference between monthly mortgage payments ($797) in the stock market every month for 30 years. To do this, we assumed the same 7% average annual rate of return.
Scenario 1: Invest Gradually While Paying Off Your Mortgage in 30 Years
First, we’ll see how much a $500,000 home will cost over time with a 30-year mortgage. Remember, Monica is putting the full 20% down, meaning her loan will be for $400,000.
With a monthly mortgage payment of $2,350, Monica will pay a total of $845,842 over the 30-year term of the loan, including a whopping $445,842 in interest payments.
However, the lower monthly payments also allow her to begin growing a nest egg in the stock market much earlier. Since her mortgage payment is $797 less than what it would be with a 15-year mortgage, Monica invests that money every month and watches it grow to $977,952 over the course of the 30-year period. Not bad at all!
Scenario 2: Pay Off Your Mortgage in 15 Years and Then Invest
If Monica instead opted to purchase her home using a 15-year mortgage, her monthly payment would be $3,147. However, the larger monthly payment and shorter duration of the loan means she’ll pay less in interest in the long run. By the end of the 15-year term of the loan, she would have paid $566,375, including $166,375 in interest.
After paying off the mortgage in full, she turns her attention to her investment portfolio. As explained earlier, she begins investing the full $3,147 in the stock market every month starting in the 16th year. Over the next 15 years, her money grows to $1,003,149, assuming an average annual return of 7%.
Not only does the 15-year scenario result in Monica spending less money on her mortgage over the duration of the loan, but she also ends up with more money in her investment account. By paying off her mortgage first and then redirecting her monthly payment into the stock market in years 15 through 30, Monica builds a nest egg worth $1,003,149.
Had she gone with scenario 1 and invested while paying off her 30-year mortgage, she would still have a sizable nest egg of $977,952, but slightly less than scenario 2.
When factoring in the cost of a 30-year mortgage, Monica’s net investment (her nest egg minus P&I) would be $132,110 compared to $436,774 in the 15-year scenario. That means she nets an extra $304,664 going with the 15-year option compared to the more conventional 30-year approach.
Tips for Managing Your Housing Costs
- Work with a professional. While financial advisors typically associated with investment advice, they can also evaluate your housing costs and help you potentially find savings in your budget. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Mortgage rates are more volatile than they have been in a long time. Check out SmartAsset’s mortgage rates table to get a better idea of what the market looks like right now.
- Consider your options. Don’t know whether now is the time to buy or continue renting? SmartAsset’s Rent vs. Buy Calculator can help you determine which is the better financial move based on where you live.
- Don't forget about property taxes. If you’re thinking of buying a home, don’t forget to consider property taxes. Depending on where in the U.S. you’re planning to buy, property taxes can vary dramatically. Use SmartAsset’s Property Tax Calculator to get a sense of how much your annual tax bill may be.
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