My original version of this blog entry has been deleted because I did find some errors in my spreadsheet. I saw them when I was explaining what I thought I had found while doing my calculations. The new calculations are not as I thought they were, but still some interesting things can be extracted from it.
I was reading a blog entry where one couple in Seattle had a hard time trying to find a place where they could take out a mortgage for 15 years. One woman in another blog commented that 15 years is a bad idea, and better would be a 30 year mortgage because it lets you buy more house.
Comments like, “ooh better get a 30 year mortgage than 15 year mortgage” raise my hackles! I don’t believe such comments and decided once and for all to figure out what the numbers are.
There are two variations to this scheme:
1) Get the same mortgage, but invest the monies
2) Get a bigger monies for the same amount that you would pay monthly.
Ok, so I created an Excel spreadsheet that anybody can download to verify if I am right or wrong. Folks, please verify my spreadsheet because I want to know if I accounted for everything, because I found out something very very interesting.
I made the following assumptions for variation 1:
- 300,000 mortgage
- 30 year mortgage at current rates (5.75%)
- 15 year mortgage at current rates (5.52%)
- Interest only mortgage at current rates (5.53%)
- Renting at 2,000 per month
- Income of 90,000 with tax rate of 25% with interest paid deducted from yearly income.
- 1.5% of 300,000 charge per year for maintenance, etc
- 9% return on alternative investments
- 5% return on the price of housing
- The difference in monthly payments are invested into alternative funds
For variation 2 I made the following assumptions:
- 300,000 mortgage for the 15 years
- 530,000 mortgage for the interest only
- 420,000 mortgage for the 30 years
- 30 year mortgage at current rates (5.75%)
- 15 year mortgage at current rates (5.52%)
- Interest only mortgage at current rates (5.53%)
- Renting at 2,000 per month
- Income of 90,000 with tax rate of 25% with interest paid deducted from yearly income.
- 1.5% for yearly fees of the original price of the property.
- 9% return on alternative investments
- 5% return on the price of housing
- The difference in monthly payments are invested into alternative funds
Running the numbers I decided to sell after 10 years. At that time I decided that I would buy another house using the same prices.
Here is what I found for variation 1:
It does pay to get an interest only mortgage and invest the monies. At year 10 you pocket with the interest only 374,000, and the 15 year mortgage 323,000. This means you get 50,000 more by investing. However, this implies that you will invest the monies and get 9%. Granted both returns I searched and found on the Internet so they are averages over a time span of about 35 years.
If you only invested half the monies that the interest only gives you then you will be at a disadvantage. If you invest none of the monies then you will be at a massive disadvantage. In other words you will see the same amount less per month whether you use interest only or 15 year mortgage.
The tax advantage of the interest only vs the 15 year mortgage in year 10 is barely 200 USD, which in my opinion is nothing to write home about.
Here is what I found for variation 2:
Variation 1 was not what the original blogger was talking about. Variation 2 where you buy more house for your money was what the original blogger talked about. This means you would be investing nothing, and doing the numbers for this variation the results are not good.
Yes you can afford more house eg 530,000 vs 300,000, but after ten years it means you pocket less money 292,000 vs the 15 year mortgage 322,000. What I found particularly interesting about this variation is the associated risk. Your tax advantage in year 10 is greater (400 USD), but you have more costs since a more expensive house has higher taxes, etc. Additionally if you purchase a higher priced house there is a greater liklihood that you will not be able to sell your house.
Conclusion:
In my original blog entry, which I deleted, I said that the money you pocket is greater by paying off the mortgage. When I fixed my calculations for Variation 1 it was not the case, but it was the case for Variation 2. Though, what is extremely important to realize is that interest only or long term mortgages only apply if in the long term the markets and housing prices go up. If during the 10 year period you don’t get the required returns you are buggered. For example I did the calculations when both the investments and housing prices only increased by a mere 2% per year over a 10 year period. At that point the money that you pocket goes way up for the 15 year mortgage, and for the others you are left straddling quite a bit of debt.
So in the end it might cost more per month, but it is better to get a 15 year mortgage…