15 or 30 Yr Mortgage: How A Right Mortgage Term Can Build You Wealth?
Making the right decision has the power to take you from where you are and where you want to be. Likewise, choosing the right mortgage term can help you build wealth in time if you make the right decision. So if you are in the market to buy an investment property, and confused between choosing 15 or 30 yr mortgage. This is something you need to know.
Taking a 15-year mortgage may appear to be a profitable one but it is not a wise decision unless you don’t have a plan to scale your rental business. A 15 yr mortgage can have a lower interest rate and can save lots of money on paper. But it is the 30 yr mortgage that gives you the best returns on your money.
Why is the 30 Yr Mortgage term best suited for your goal?
If you share the same goal of wealth building as I do with rental investing. I can assure you that it is the 30 yr mortgage that you should go for. It is better if you can understand in time that you need to use debt to get rich with real estate. But with a 15-year mortgage, you are letting the other`s people money aka debt escape faster than it could be used to make you richer.
A 30 Yr mortgage has small monthly payments as compared to 15 yr term. You can use the remaining cash flow to further invest in more cash flowing properties. The difference you think you save in interest payments by opting for a 15 yr mortgage may look bigger on paper. But a smart investor definitely knows how to multiply that money by investing it wisely.
Evaluating a 15 Year Mortgage Vs 30 Yr Mortgage in Action
Let`s first take into account a 15 Year Mortgage Scenario while borrowing $200,000 for buying a rental property. Generally, the 15-year Mortgage has a fixed 3.3% interest rate. Your monthly mortgage payment will then become $1410. You have to pay $53,837 in interest in 15 years along with $200,000 in your principal payments.
15 Year Mortgage
- Mortgage Amount: $200,000
- Interest Rate: 3.3%
- Monthly Mortgage Payment: $1410
- Interest to Pay: $53,837
Now, let`s evaluate the same scenario with the 30 yr mortgage. A 30 yr mortgage, in general, has 4.5% fixed rates. A $200,000 borrowed amount will then have a $1013 monthly mortgage payment. You will pay $164,810 in interest along with $200,000 in principal payments for a 30 Yr mortgage term.
30 Year Mortgage
- Mortgage Amount: $200,000
- Interest Rate: 4.5%
- Monthly Mortgage Payment: $1013
- Interest to Pay: $164,810
Does a 30 Yr Mortgage then make sense?
Comparing the 15 yr to 30 yr mortgage, you will be paying almost three times the interest in 30 years that you would pay in 15 years. So how can a 30 yr mortgage make sense? After all, you will be paying $110,973 more in lieu of just saving $397 every month. You might now feel why not pay $397 more every month and save your precious $$$ ($110,973 exact in this case).
But let’s also take this into consideration
- Saving $397 every month for the next 30 years straight makes it a total of $1,42,920. Now if you take these savings into account, you will be saving $31,947 ($110,973-$1,42,920) if you opt for a 30-year mortgage.
- What if you just put these $397 every month in a CD account? This money will become $181,149 if it only earns 1.5% interest for 30 years in a recurring CD account.
Now you can understand yourself why 30 yr mortgage makes more sense over a 15 yr mortgage even if you have a higher interest rate. You can clearly see how much you can save by going for a 30-year mortgage. Though, there are still more benefits of choosing a 30 yr mortgage over a 15 yr one that might amaze you.
Note: If I were in this situation, I would not save the $397 every month, rather invest it. Saving is for losers. The value of your money is depreciating with every passing time. This extra money ideally should bring you much more dollars than it should be paid back to the lender.
Read: How I invest this cash flow to generate bigger returns?
Why go for 30 Yr Mortgage vs 15 Yr Mortgage?
You can stay more flexible with a 30 Yr mortgage. A 15-year mortgage has a higher mortgage payment every month. If something ever goes wrong, you can find yourself in muddy waters. But with a 30 yr mortgage, you still have a little extra cushion to absorb such surprises.
Also with a 30 yr mortgage, you can build some emergency funds for such desperate situations. Not to mention, you can always repay your 30-year mortgage early with the extra cash you are saving every month.
“Paying the extra $397 along with your mortgage payments every month, your loan will be shortened by 13 years and 1 month. Your loan will be paid off in exactly 16 years and 11 months. The interest saved will be $78,891 and the interest you will pay is just $85,919.
You must be aware of the fact that the IRS allows certain deductions on the rental income you earn. The interest you pay each year on your mortgage is also eligible for deduction. Having a 30-year mortgage, you can take this deduction for 30 years. But what if you pay off your mortgage in 15 years? You are not allowed to take this deduction anymore.
Read: What are the Tax Deductions available for Rental Investors?
The value your money holds today will not be the same in the coming years. Its value will keep on depreciating over time. The money you are paying today holds more value than it does in the future. However, your mortgage payments are going to stay the same. Though, the money that will go against the mortgage in the future will be worthless.
Also, you might know that the lenders pull out maximum interest in the initial years of the mortgage term. This means you are pushing back a lot of your purchasing power of dollars in the initial years if you are opting for a 15-year term. Technically, this money should be used to invest and buy more cash flowing assets. So, why hurry to make the payments in 15 years when you can pay in 30 years?
Less Debt to Income Ratio
Having a small debt to income ratio means you can qualify for more loans and can easily score more rentals in your portfolio. But when you obtain a 15-year mortgage, your monthly payments become higher as compared to the 30 yr term. This affects your ability to obtain more mortgages.
Things to watch with 30 Yr Mortgage
A 30-year mortgage is what you should be opting for. But still, there are few things you need to put into consideration when obtaining financing. Evaluate your situation before you zeroed down the term of your mortgage.
Build Equity Slower
You build equity at a slow pace as you do with a 15-year mortgage on an investment property. Equity is the actual value you hold in your property. It is the difference between the current market selling price minus the remaining amount in the mortgage.
With a 15 year mortgage, you pay down principal faster as you do with a 30-year mortgage. This way you build more equity in less time with a 15 yr mortgage. The benefit of building equity in less time makes sense when you have a plan to sell your investment property in the near future. And from my understanding, selling a cash-flowing asset is like cutting a fruit-bearing tree.
Higher Closing Costs
There are always some closing costs associated with a mortgage. Most buyers typically spend about 2%-5% on closing costs. When you obtain a mortgage for a longer tenure, the lender charges a little extra in terms of closing cost than he would in shorter duration loans.
Longer duration loans are a little less profitable and riskier for banks as compared to shorter-duration loans. No wonder why banks push you to go for 15-year loans instead of 30-year loans. With a 15 year loan, banks have a higher chance to have you refinance your loan. Most banks will want you to pay for mortgage insurance with a 30 yr mortgage even if you are putting 20% down.
A rental investor mostly has more than 2-3 mortgages in his name. When you have more than one 30 year mortgage, lenders hesitate to lend more. Lenders instead of offering fixed-rate mortgages for 30 years then prefer to lend with an adjustable rate. The meaning of ARM is you have a fixed rate for a certain duration say 5-7 years and then the rate fluctuates accordingly after that.
If you are in this situation and getting an ARM instead of getting a fixed one. You can occur to negative cash flow if you aren’t careful. Though you always have that extra cushion with a 30 yr mortgage. But still, keep an eye that your cash flow can sustain that extra payment if the rate adjusts.
Read: When you should not sell your Negative Cash Flowing Rental Property?
A 30 yr mortgage is a boon for a rental investor. Waste no time in eliminating the 15 yr mortgage option out of your play. You can have no better opportunity than obtaining a 30 yr mortgage to start investing in rental properties.
Also Read: How to start investing in Rental Properties with zero money down?