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Conventional Wisdom Regarding Your Mortgage

Holden Lewis, Mortgage

With Holden Lewis, Senior Mortgage Analyst and Senior Editor at bankrate.com

The conventional wisdom regarding home mortgages is that the 15-year is better than the 30-year plan in the long run. After 15 years, you’ll own your home free and clear, a basic tenet of the American dream, and you’ve paid fewer fees and a lower interest rate.

Holden Lewis, Senior Editor at bankrate.com and a senior mortgage analyst, recently wrote an article focused on the drawbacks of taking out a 15-year mortgage, why people typically opt for them as opposed to a 30-year mortgage, and why they often refinance at some point into that 15-year period.

On the surface, it appears that the main drawback of the 15-year mortgage is a higher monthly payment. Holden says that part of the appeal is the emotional satisfaction that comes with knowing you can have your home paid off in a shorter period of time and, that when that day comes, no matter what happens, your safety net, your security zone, is that home.

But a deeper analysis reveals that having a 30-year mortgage actually gives you more flexibility and security in hard times. As Holden explains it, “Let’s say the car needs a big repair and someone is hospitalized.  All of a sudden, you’ve got all these huge bills.  If you have a 30-year loan with that smaller monthly payment than a 15-year loan, then you just have more room to pay all of your bills, including your mortgage.” You’d be better prepared for any of life’s unexpected events.

He advises taking out a 30-year loan and paying extra on that mortgage each month as long as you can. Assuming there is no financial crisis along the way, you have the potential to have the same benefits of a 15-year loan with less interest paid and full home ownership in less time.

With a 30-year loan, you also have the option to refinance into either a 15-year loan or into another 30-year loan with a lower interest rate. “If you refinance into another 30-year loan under the scenario I have,” says Holden, “if you pay an extra $530.00 a month on this $200,000.00 mortgage, you’ll end up paying it off in 15 years, but if you get a 15-year loan, it’s $73.00 less than that $530.00 extra.” You get a break on the interest rate with a 15-year and, again assuming a $200,000 loan amount, you would be ahead $73 a month, an amount you can use for savings.

Paying less on that monthly mortgage offers the possibility to set aside an amount to invest in, perhaps, a basket of common stocks such as the S&P 500, which over a 10 or 20-year period, statistics show would have a higher rate of return than investing in your home.

In addition, cautions Holden, “…it would be utter madness to be paying off your mortgage in 15 years when you’re carrying a balance on a credit card that has an interest rate of 12% or 18%.”  So before you go for a mortgage, know all the facts and determine what’s in your best interest.

Disclosure: The opinions expressed are those of the interviewee and not necessarily United Capital.  Interviewee is not a representative of United Capital. Investing involves risk and investors should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions.  Content provided is intended for informational purposes only, is not a recommendation to buy or sell any securities, and should not be considered tax, legal, investment advice. Please contact your tax, legal, financial professional with questions about your specific needs and circumstances.  The information contained herein was obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed. All data are driven from publicly available information and has not been independently verified by United Capital.

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Steve Pomeranz: We all like to think out of the box here from time to time by questioning conventional wisdom, and it looks like Holden Lewis, Senior Mortgage Analyst and Editor at bankrate.com, is doing the same.  I’ve asked him to come in and talk about his article on the drawbacks of taking out a 15-year mortgage. Hey, Holden, welcome back to the show.

Holden Lewis: Hey, thank you.

Steve Pomeranz:  Real quick, for those who perhaps never have had a mortgage or are not familiar much with mortgages, what is a 15-year mortgage and how does that differ from a conventional 30-year mortgage?

Holden Lewis: A 15-year mortgage is a home loan that you pay off in 15 years, so 180 months instead of 360 months for the standard 30-year mortgage. That’s one of the differences. The other difference is that a 15-year loan tends to have a lower interest rate and the fees are less, so you have those two things, but the monthly payments on a 15-year mortgage are a lot higher than on a 15-year loan.

Steve Pomeranz: Sure.

Holden Lewis: Now you save a whole lot in the long run on interest.  You just pay a whole lot less interest when you pay a loan over 15 years instead of 30 years, but that monthly payment, it’s a lot higher.

Steve Pomeranz: Yeah. It’s like when you go to buy a car and you decide, “Well, do I want a 3-year loan or a 5-year loan?” If you got a 3-year loan, you pay the car off sooner. You’re not going to be paying interest for that extra two years, but the payment is going to be much higher.  A 5-year loan, obviously, it’s spreading it out over …  You’re paying more interest, but then the payment is lower.  It’s really no different in the mortgage market, only you’re talking 15 and 30 years, right?

Holden Lewis: That’s exactly right. Here’s the thing. We had an article that had been written a long time ago, maybe 6, 7 years ago, about refinancing into a 15-year mortgage, and that is a popular article.  A lot of people read it.  I decided, “Well, I should update that story because it’s so popular.” There was a little section, but not much, about the drawbacks of refinancing into a 15-year loan, and I decided, “Well, you know, let’s just update the story about kind of why people get 15-year mortgages, why they refinance into 15-year mortgages, and then break out separately an article with more detail about those drawbacks.”

Steve Pomeranz: That article definitely got my attention.  I think another positive or another reason that people are very attracted to 15-year mortgages, if they can afford them, is that I believe that it’s in the American consciousness to have your home paid off.  Would you agree with that?

Holden Lewis: Yes. It’s really emotionally satisfying to a lot of people to have that home paid off and to be picturing that, to say, “Oh, in 10 years I’ll have this house paid off.”

Steve Pomeranz: Yeah, because that’s such a large monthly payment.  Plus, you know that nobody can take it away from you, that if economic times change, you don’t have a mortgage you have to keep up, and you would be out of those kinds of troubles.  It gives a person a sense of security, a sense of safety.  I think that’s a lot of the reason that people are always looking at 15-year mortgages.  You were talking about some of the drawbacks, though, so let’s take the other side of this coin.  Start off with one drawback on a 15-year mortgage.

Holden Lewis: Right. The first drawback I’ll talk about doesn’t have really a whole lot to do with dollars and cents.  It’s more of an emotional safety type issue, and that is that having a 30-year mortgage gives you more flexibility in hard times.  Let’s say the car needs a big repair and someone is hospitalized.  All of a sudden, you’ve got all these huge bills.  If you have a 30-year loan with that smaller monthly payment than a 15-year loan, then you just have more room to pay all of your bills, including your mortgage.  If you have a 15-year loan, you have less flexibility.  You still have to make that monthly payment, and you have less room, of course, to make other bill payments.

Steve Pomeranz: It brings the point forward that perhaps you should take a 30-year mortgage and just pay extra on that mortgage every month to bring it down to a 15-year mortgage.

Holden Lewis: Right.  In my article, I have a diagram that just sort of shows three ways to go about it.  Now this is assuming that you already have a 30-year loan and you’re trying to decide, “Do I refinance into another 30-year loan or do I refinance into a 15-year?” If you refinance into another 30-year loan under the scenario I have, if you pay an extra $530.00 a month on this $200,000.00 mortgage, you’ll end up paying it off in 15 years, but if you get a 15-year loan, it’s $73.00 less than that $530.00 extra, if you see what I mean.

Steve Pomeranz: Why would it be less?

Holden Lewis: It would be less because you had a smaller interest rate.

Steve Pomeranz: Yeah, so there is a rate differential between a 30-year.  In your example, you priced a 30-year at 3-5/8, but the 15-year was at 2.875, so 3.625 versus 2.875.  You get a break on the rate, as you said earlier, with a 15-year, and in your example, a $200,000.00 mortgage, that’s a difference of about 70 bucks a month.

Holden Lewis: That’s right.

Steve Pomeranz: Okay.

Holden Lewis: The 15-year would cost about $73.00 less a month than paying the 30-year loan off in 15 years, which I know that’s kind of a complicated concept.  It’s easier when you’re actually looking at it on a screen, on a piece of paper.

Steve Pomeranz: Yeah. I think the point you’re making is if you have a 30-year, while it may be a little bit more expensive, if you have an unexpected event like you mentioned, your car and maybe a health event at the same time, you can then decide not to make that $530.00 payment, and it gives you more flexibility.  I think that’s the other part of your article that you bring to the fore, is that thinking more 30-year and paying down more every month gives you more flexibility.  What would you add to that?

Holden Lewis: Really, to me, kind of the main issue is that you just have more flexibility, but there is another reason to refinance into a 30-year instead of a 15-year, and that has to do with savings.  You can save that extra money.  In other words, you can pay off that mortgage in 30 years instead of adding that $530.00 a month and paying it off in 15.

Steve Pomeranz: That extra money that you’re putting down, in effect, if you think of it as an investment, you’re now taking your extra money and investing it in your house.

Holden Lewis: You’re investing it in your house, and the return is low.

Steve Pomeranz: Yeah.

Holden Lewis: Think about it.  Let’s say you’re paying an interest rate of 3-5/8%, and let’s say you also are deducting the interest on your taxes.  That lowers your effective interest rate to, I don’t know, something like 3%, maybe a little bit less than 3%.  That’s your effective return on that investment of that extra $530.00 a month.  Now if you could invest that into something else with a better return, that probably makes more sense.  Now that’s not just savings, of course, because if you have high-rate debt, like on a car loan or a credit card, makes a whole lot more sense to throw that $530.00 a month into that higher-rate debt.

Steve Pomeranz: I agree.

Holden Lewis: Also, it probably makes more sense to put that money into something that you can get a higher return, and it’s savings, either emergency savings or retirement savings.

Steve Pomeranz: Human beings have a tendency to put things in compartments, compartmentalizing their thoughts.  We think about paying extra on the house.  The house is just kind of this stand-alone idea, and I’m going to get that mortgage down to zero and that’s it.  If you don’t compartmentalize and you think of the house, well, it’s an asset.  Yes, it’s real estate.  Of course, I have to live somewhere.  It’s not really an investment asset per se, but it has the probability of maybe growing at the rate of inflation over time.  I’m now choosing one investment over another.  Should I invest in my home or should I invest in, let’s say, a basket of common stocks like the S&P 500, and over a 10 or 20-year period, I think statistics show that it’ll have a higher rate of return than you investing in your home, and you have the further benefit of this extra liquidity because now the money’s not tied up in your house.  Right?

Holden Lewis: That’s exactly right.  Of course, just to get back to that interest thing, I think it would be utter madness to be paying off your mortgage in 15 years when you’re carrying a balance on a credit card that has an interest rate of 12% or 18%.  I think a lot of people, they know that intellectually, but they might not live it.  I think there’s probably a lot of people out there who are paying extra every month and carrying balances on their credit cards.

Steve Pomeranz: Yeah, it’s compartmentalizing.  It’s not thinking of your debt as one big area.  It’s your credit card debt, and you’re paying payments on that and you’re maintaining that in whatever way you do.  Then you’ve got your house here in this little silo, in this little box, this little drawer in your closet or something, and it’s sitting there and it’s separate, but they’re not separate.  They’re all together.  If you got a rate of 3% or 3-1/2% on a 30-year mortgage, even Warren Buffett says he would borrow money at 3%, at 3-1/2%, he’d go out 100 years if he could because those rates are just so unbelievably low.

My guest is Holden Lewis, Editor from bankrate.com and a senior mortgage analyst.  Holden Lewis, thank you so much for joining us.

Holden Lewis: Thank you.

Steve Pomeranz: To find out more about Holden and to hear this interview again, don’t forget to join the conversation at onthemoneyradio.org.