15 or 30 year mortgage?

Question

So I'm looking to buy an sfr in Fresno as a rental investment.  I would enjoy the cash flow until I retire in 20 years and then most likely sell it to help fund my retirement years.  I have two options for the mortgage and wonder what conventional wisdom says is the best route to take.

Option 1: 15 yr fixed rate mortgage.  Cash flow $50/month not including property management.  When it's paid off in 15 years the cash flow is $1,200/month (if today's numbers never change, for the sake of argument).  Then sell it 5 years later.

Option 2: 30 yr fixed rate mortgage.  Cash flow $270/month not including property management.  Sell in 20 years - before it's paid off.

It seems like option 1 gives me more cash at the 20-year mark, but then I miss out on 15 years of cash flow.  Thoughts?

Bob Anderson · Answer

Most investors opt for the 30 year loans when possible.  It tends to be the less volatile option since it requires a lower monthly payment.  For example lets assume the 30yr mortgage is 1k / month, and the 15yr plan is 1400/month.  When times get rough and the economy tanks, and your tenant moves out, and your hot water heater explodes, which would you rather pay, 1k or 1400?  By having a lower monthly payment it helps to protect you when things go wrong, and at some point things will go wrong.

A 15yr tends to look attractive when you see that it has a lower interest rate, and you will pay significantly less in total interest over the life of the loan.  But let me ask you this, would you rather have $1,000 today, or $1,000 30 years from now?  The answer is easy, you would want 1k today because thanks to inflation the 1k 30years from now won't buy you nearly as much stuff as the 1k today will.  The same principle applies to your loan.  Ideally you want to pay as much as you can with 'future' money, and as little as possible with "todays" money since todays money is worth more.  The 15yr loan pays off the loan very rapidly and therefor uses more of todays money.

Jeff Zimmerman · Answer

@Douglas Goldstein i like your plan, I'd probably do the 30-year mortgage, only so that you max your cash flow initially in the event that something goes wrong and you need cash to make repairs, etc...  With a 30 year loan, you also have the option of paying down the loan using your cash flow if you have extra cash.  with a 15 year you won't' have that option, you will be forced to pay more into your loan.   The nice thing about a 15-year loan, however, is that it forces you to make that payment and pay the home off early.....so if you want flexibility, 30-year loan.  If you want more structure in the loan, 15 year.  Does that make sense?

What part of Fresno are you looking in?

Todd Willhoite · Answer

Scott Trench wrote a blog article on the subject with a spreadsheet you can download.  What are you going to do with the excess cashflow from a 30yr mortgage?  Are you going to spend it, or invest it?  In Scott's blog he assumes investing it into an S&P 500 index fund.  Under his default settings on the spreadsheet the 30 year mtg leads to greater wealth.  The nice thing about the spreadsheet is you can run your own numbers and see what happens.  I just did a 30 yr refinance and put my numbers in the spreadsheet.  My interest is higher than his default.  I assume the stock market is not going to perform as well as his defaults based upon the current dividend yield of the S&P 500 and the overall return over the last 5-10 years.  Under my situation it looks like 30 year mtg comes out slightly ahead of 15 year net worth, but cash flow from year 15 until 30 blows away the 30 year mtg until year 30.

A 30 year mtg will probably come with a higher interest rate, but you are buying the flexibility to pay the lower rate. You can always pay it like a 15 year mortgage with the extra going to principle until you want or need to pay the 30 year rate.

Mike McCarthy · Answer

I always like the 30yr option (unless the 15yr has a significantly lower interest rate) since it gives you options.

If you’re looking to pay off the mortgage quicker and attain more equity, just pay an extra $$ each month. You’ll turn your 30yr into a 20/15/10 year mortgage and pay significantly less interest.

But if you (like a lot of investors here) want to leverage low interest rates, you can pay the minimum amount each month and invest that extra money into another property that’s making you 10-15%. Basically, you’re borrowing money at 5-6% to make 10-15%. Not a bad deal!!

15 or 30 year mortgage?

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