I will never choose a job where I’m going to have to do math.
In 8th grade, that was a pretty non-negotiable part of my future. And look at me now, crunching mortgage numbers behind a desk for The Espinal Adler Team. That old/young me with a mullet would look at me now and say, “How the hell did you let this happen? And what happened to our hair???”
I’d have to explain to my younger self that numbers are an acquired taste, like beer. One day your tongue can’t stand the taste of it, and the next day you’re looking up inside your own head running algorithms in your imagination just for fun.
Okay, that was a little overboard, but the truth is, I kind of dig the math at work. It’s not genius level, but just enough to keep a guy in his 40s sharp for the long haul.
When I talk to a client about the pros and cons of taking a 15-year fixed rate mortgage instead of a 30-year fixed rate mortgage, it’s really a conversation about math. If you can handle a higher payment, the 15-year fixed rate mortgage is a much more cost-effective way to borrow money.
For the sake of example, let’s assume two brothers named Ronny and Johnny purchased a home and each of them opted to take a mortgage for $1 Million. Ronny took a 30-year fixed rate mortgage with an interest rate of 2.875%, and Johnny took a 15-year fixed rate mortgage with a rate of 2.25% (15-year fixed rate mortgages almost always come with a lower rate compared to a 30-year fixed rate mortgage).
Ronny’s monthly payment is $4,149.
Johnny’s payment is $6,551, a difference of $2,402 per month.
Over the life of the loan, Ronny would pay $493,612.92 in total interest payments.
Over the life the loan, Johnny would pay $172,152.59, a savings of $321,460.33
After living in his home for 7 years, if Ronny only made his regularly scheduled mortgage payments the balance on Ronny’s loan would be $834,948.
After living in his home for 7 years, if Johnny only made his regularly scheduled mortgage payments the balance on Johnny’s loan would be $569,566.
I walked through this scenario dozens of times in my career, maybe more than a hundred times. And I gave the same advice every time. “If you can comfortably afford the higher monthly payment, you will thank yourself later if you choose the 15-year fixed rate mortgage. Your house might be paid off by the time your kids are going to school.”
It’s sound advice, and I still stand by it, but last week I was presented with an alternative perspective and I was reminded that sometimes, there are multiple intelligent options to choose from.
Here’s what happened:
As an added benefit to our clients, I’ve started using Mortgage Coach so I can present numbers on a completely interactive and simple to understand platform. The software is used almost exclusively by mortgage originators. In fact, if I had to guess, we’re the only real estate team in the world using Mortgage Coach.
Anyway, you don’t have to look for too long to find Mortgage Coach videos designed to teach users different strategies and presentations that they could later share with their clients.
I clicked on a video presentation about a 15-fixed vs. 30-fixed mortgage. The longtime Mortgage Coach user presented both options on a screen side-by-side, and he used the two-brother scenario to differentiate between the two scenarios. He didn’t specify that their names were Ronny and Johnny. But this Rockstar loan officer did take his presentation to another level.
He proved that choosing the 30-year fixed rate option might be the smarter option for extremely savvy and extremely disciplined individuals. The software allowed him to take the difference between the two payments – in my scenario above, $2402 per month – and over a 7-year horizon he earned a 6% rate of return in a competitive investment vehicle.
Again, using my figures,
After 7 years, Johnny, the brother that chose the 15-year fixed rate mortgage would have $430,434 in equity in his home, not counting any gains from appreciation.
Ronny, on the other hand, would only have $165,052 in equity, which is the difference between the mortgage balance and the original loan amount (or current appraised value if you are taking appreciation into account).
I’m still thinking it’s a slam-dunk. The 15-year fixed rate mortgage is the more cost-effective option, after all, Johnny had $265,382 more in equity than his brother Ronny.
But then, the mortgage coach genius, showed what happened to those $2402 payments that Ronny was making into the investment vehicle that yielded a 6% annual rate of return. It was more than the $265,000 that Johnny had in equity.
Then he took it a step further. “Imagine Ronny and Johnny both lost their jobs seven years after they bought their homes. Without a job, Johnny didn’t qualify to borrow against the equity in his own house. Meanwhile, between jobs as well, Ronny was liquid for more than $265k.
Finally, this Mortgage Coach genius also reminded me that Ronny was paying a little more in mortgage interest each year through the 30-year fixed, so he actually got a better deduction along the way, another advantage to taking the 30-year fixed rate mortgage.
The Final Tally
Both options are smarter than choosing the 30-year fixed rate mortgage and only making the regularly scheduled payments. But one path requires an enormous level of self-discipline as well as expert guidance on properly investing each month. The 15-year fixed is forced discipline. It’s not quite as good as how the other scenario played out, but it’s cost-effective and you don’t have to think too much.
Bottom line… There’s more than one way to skin a cat.
Pro Tip: stay away from people who literally know more than one way to skin a cat. They’re likely dangerous. And remember, math is kind of cool. Sometimes.