Article Excerpt
What's the truth on 15-year vs. 30-year vs. renting scenarios when it comes to return on investment? In this example, there's an obvious answer.
Let’s take a look at a hypothetical homebuyer who lives in the same place for their entire adult life. We’ll name her Jennifer.
For simplicity’s sake, let’s say that Jennifer lives there from age 25 to age 75. In one timeline, she buys the property with a 30-year mortgage. In another, she gets a 15-year mortgage. In a third timeline, she rents the property for the entire 50 years that she lives there. Which version of our hypothetical hero has made the best financial choice?
Let’s examine the numbers so you can form an educated opinion.
What’s the total cost of a 15-year mortgage?
The 15-year mortgage in this example (with a home value of about $362,000) will cost the homeowner a total of $612,000 by the end of its term. After the term ends, the homeowner is still responsible for property taxes.
Jennifer buys a home for $362,250 in September 2021 at age 25. She makes a 3.5% down payment (the minimum required with the FHA loan program) and takes out a 15-year, $350,000 mortgage loan.
15-year mortgages tend to have lower interest rates. She locks in a fixed 2.37% rate on her mortgage. Using our handy mortgage calculator, we can determine how much Jennifer will pay over the course of the mortgage term.
Jennifer’s monthly mortgage payment might be around $3,400. This includes principal, interest, taxes, and insurance. This does not take the typical rising of property taxes into consideration. But we’ll be fair and apply the same rules to our 30-year mortgage and renting scenarios in the following sections.
» READ MORE: The Four Parts of a Monthly Mortgage Payment
Because of amortization, most of her early payments will consist of interest, with the remainder going towards the principal of the loan. As the principal goes down, so does the interest each month. Each payment consists of less interest and more principal until she pays off the principal in 2036.
» READ MORE: What is Mortgage Amortization? How Does it Affect You?
Over fifteen years, Jennifer will pay an estimated $66,232 in interest. With the principal added, it’s $416,232. With principal, interest, taxes, and insurance combined (every part of the mortgage payment) she will have paid $612,000.
What’s the total cost of a 30-year mortgage?
The 30-year mortgage in this example (with a home value of about $362,000) will cost the homebuyer a total of $883,080 by the end of its term. After the term ends, the homeowner is still responsible for property taxes.
Let’s assume all the same facts as before - but this time, Jennifer gets a 30-year mortgage with a fixed interest rate of 3.05 percent. She might expect a monthly payment of $2,453 to be paid off in September 2051.
By the time Jennifer’s 15-year mortgage is complete, she will have paid $184,624 in interest. Adding the principal, that’s $534,624. With principal, interest, taxes, and insurance combined (every part of the mortgage payment) she will have paid $883,080.
How much would it cost to rent during the same amount of time?
The amount it would cost to rent a property depends on more factors than we can include in one hypothetical, but we can make a few assumptions.
Landlords often set monthly rent at around 0.8 to 1.1 percent of the property’s value. In Jennifer’s case, that would mean monthly rent between about $2,900 and $4000.
Photo by chris robert on Unsplash
Let’s say her landlord charges toward the lower end of this range: $3,200 per month. Jennifer will pay $38,400 per year, for a total of $1,920,000 from 2021 until 2071.
This does not take rent increases into consideration through those fifty years.
How do these costs compare?
Would you pay nearly $2 million to live in a house owned by someone else for five decades, only to be unable to pass it to your heirs?
If her home’s value increased by 3.5% each year, which is the average for residential real estate, the original $362,000 home would be worth over $2 million dollars in fifty years. Even if it weren’t a multi-million dollar property, Jennifer would have something to show for all the money she put into the home.
As a renter, she is left with nothing after fifty years.
Photo by Steven Ungermann on Unsplash
Now let’s look at how the costs compare directly:
|
Total amount spent over fifty years (continued property taxes of 2.5% included) |
Tax deduction opportunity from mortgage interest alone |
Est. resale value after fifty years (3.5% value increase each year) |
|
|---|---|---|---|
15-year mortgage |
$918,250 |
$66,232.75 |
$2,000,000 |
30-year mortgage |
$1,058,080 |
$184,624.85 |
$2,000,000 |
Renting |
$1,920,000 |
$0.00 |
$0.00 |
» READ MORE: Homeowners: Do You Know About These Tax Write-Offs?
It is worth noting that few homeowners actually keep a house for the entire life of a mortgage. A 30-year mortgage offers advantages to someone who anticipates that they will sell the house before the thirty years are complete.
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