August 11, 2016 

The 15-year fixed-rate home mortgage is far and away the best option for consumers because of the low interest rate. All other things the same, including originations fees, the 15-year rate in today’s market is 0.75% below the 30-year rate. 

I recently assessed a $240,000 loan to a borrower with a high credit score who will put 20% down. The lenders reporting prices to my site quoted 2.50% on a 15-year mortgage and 3.25% on a 30. The total interest paid over the life of the 15 would be $48,054, while over the life of the 30 it would be $136,320.  That is, for every dollar of interest paid on the 15, the borrower would pay $2.84 of interest on the 30. That reflects both the lower rate and the shorter payment period. 

The drawback of the 15, of course, is the higher monthly payment. In the case at hand, the payment on the 15 would be $1600 compared to $1046 on the 30. What has surprised me is the number of borrower who can afford the payment on the 15, but nonetheless choose the 30 because it gives them greater freedom to spend on other things. They are present-oriented rather than future oriented, and the only thing I have to say to them is “lots of luck -- you will need it.”  

There is another group of borrowers who can afford the 15 but choose the 30 because they plan to invest the difference in payment and earn a return greater than the rate difference between the 15 and the 30. I doubt that more than one in 10 of those who have told me about their plan to do this have been able to follow through successfully, for a variety of reasons I have explained in several other articles. The crux of the matter is that the rate of return required to offset the loss of the low rate on the 15 is several percentage points higher than the rate on the 30, which very few borrowers are positioned to earn.  

The borrowers to whom this article is addressed are those who cannot afford the monthly payment on the 15 but they will be able to afford extra payments on the 30 in the future.  

The affordability of a mortgage payment as determined by lenders, regulators and most borrowers is based on earning power and is essentially backward looking.  The income used to qualify must be documented, which is looking backward. A borrower’s expectations of future earning power do not enter the picture. These expectations, however, may affect a borrower’s plans for making extra payments in the future.  

A borrower unable to meet the payment required on a 15 who anticipates an increasing ability to pay in the future can develop an extra payment game plan for paying off early – possibly in 15 years. Every such plan must be hand tailored to the individual needs of the borrower. I will illustrate with two examples.  

Jones expects a large salary increase next year, and annual increases thereafter. His game plan is to increase his payment from $1046 to $2070 in month 13, to $2170 in month 37, to $2270 in month 61, to $2370 in month 85, and to $2470 in month109, where it will remain until payoff in month 180. The reward? In addition to being out of debt in 15 years, total interest payments will decline from $136,020 when payments are made for 30 years to $68,371 with the 15-year payoff. 

Smith has fairly stable income but enjoys a sizeable bonus every year. His game plan is to make an extra payment of $8,000 in months 12, 24, 36 and so on until payoff in month 180. In her case, total interest will decline from $136,020 when payments are made for 30 years to $64,562 with the 15-year payoff. 

These two cases were developed using Mortgage Payoff Calculator 2a on my web site. To find the combination of payments that will result in a zero balance in month 180 (or any other month) involves a bit of trial and error. While every case is different, the calculator will handle them all.  

Of course, there is nothing sacred about payoff in 180 months. Some borrowers might only be able to manage 210 months while some others might be up to payoff in 150 months. The important thing is to have a concrete objective based on a realistic appraisal of what is possible, and a systematic and disciplined approach toward achieving it.