The basic premise of this post is this:
You should get the longest term mortgage that you can get. Say, 30 years.
You should try to pay it off much faster. Say, 10 to 12 years.
Note: If on the 30-year mortgage you were to pay every month as if you were paying a 15-year mortgage, you WILL NOT be able to pay off your 30-year mortgage in 15-years.
It will take you a few more payments, depending on the rates of each mortgage. That is the premium you would be paying for having lower monthly payments, but with a greater rate of interest.
But, let’s suppose, you were to pay your 30-year mortgage as if it were a 10-year mortgage, you WILL pay it faster than if you took out a 15-year mortgage and paid the standard calculated mortgage payment every month.
As an example, let’s work with the following numbers. Here is the link to the Google sheet that lays out the numbers …in all their gory details 😀
(Rates are from about 5 months ago)
Principal mortgage amount: $300,000
Rate on a 30-year mortgage: 4.5%
Rate on a 15-year mortgage: 3.875%
If you were to take out the 30-year mortgage, and if you were to make the full 360 payments, you will end up paying $247,220 in interest on your $300k loan.
But we don’t want to do that. This is the control option. We want to know what the interest number is but we will not be following this option.
If you were to take out the 15-year mortgage, and if you were to make the full 180 payments, you will end up paying $96,057 in interest on your $300k loan.
Now …the scenario we want to focus on.
In this scenario, you are paying your 30-year mortgage as if you were paying down your 15-year mortgage – i.e. you are rounding off your monthly payment to what would amount to if you were paying a 15-year mortgage, an extra $680.26 that goes directly in reducing your outstanding principal every month. In this case, you end up paying $120,893 in interest, and you pay this over 192 payment.
More than a 50% decrease from $247K to $120K. Voila! But still more than what you would pay for a 15-year ….
Why 192 payments? Because it won’t be 180 payments as less is going towards paying down the principal than if you actually had a 15-year mortgage. This amounts to paying around $96 more in per month for what I call the “premium for safety” that you pay for not taking out a 15-year mortgage.
Whew. Still with me? We have one more scenario to cover.
Now …we come to the scenario that I really want to focus on.
Look into the second sheet/tab in the worksheet.
What if you were to pay down your 30-year mortgage as if you’re paying a 10-year loan (with the rates from the 15-year loan).
You would end up paying only $76,035 in interest and pay off your mortgage in 125 months (still more than 120 payments if you actually took out a 10-year mortgage, but close enough).
I’ll repeat the theme of this post here again: Get a 30-year mortgage. Then pay it down as if you were paying a 10- or 12-year mortgage.
You will pay far less in interest, $20K in our example. But you also have the option with a lower monthly payment if you cannot accelerate fast enough.
There you go. Download the worksheet and play around with your own numbers.
There is one more scenario which in the third sheet, that tells you what is the optimal number of payments you should aim for if you want to come closest to paying the total interest if you had a 15-year mortgage. In this case it comes out to 148 payments.