The 15 Year Fixed Mortgage Is Robbing Americans of Wealth

Contrary to conventional wisdom, the 15 year fixed mortgage is basically one of the worst mortgage products you can get right now. The 15 year fixed mortgage has a very high opportunity cost, and it robs families of creating long-term wealth.

If you’re lost and confused, let me explain. It all comes down to your return on investment, opportunity cost, and the time value of money.

At the time of writing this article, the interest rate spread between a 30 year fixed mortgage and a 15 year fixed mortgage is about .77% according to the Freddie Mac Primary Mortgage Market Survey (PMMS). That’s right, the amount of interest saved for 15 years is less than 1%.

Let’s look at this another way. Pretend I’m a financial advisor and I come to you with a sales pitch for a “great” investment. All you have to do is invest $475/mo with me for 15 years, and I will guarantee you a .77% rate of return on your money over that 15 year period. No less, and no more. By the way, if you ever can’t make that payment for 3 consecutive months, you lose everything.

Would you make that investment? I really hope not.

Using the January 20, 2022 Freddie Mac PMMS, the average interest rate for a 30 year fixed mortgage is 3.560% and the average interest rate on a 15 year fixed mortgage is 2.790%. According to an article written by Experian, the average outstanding household mortgage balance is $208,185. With this information, we can calculate the principal and interest payments on a 15 year fixed and 30 year fixed mortgage. The PI payment on the 30 year fixed mortgage is $941.83/mo while the PI payment on the 15 year fixed mortgage is $1,416.75/mo. The difference in payment is $474.92/mo.

Do you want to know why a 15 year fixed mortgage gets paid off in 15 years?

Are you ready?

Here’s the secret: THE PAYMENT IS HIGHER!

15 year fixed mortgages don’t get paid off in 15 years just because the interest rate is lower, they get paid off sooner because the payment is much higher compared to that of a 30 year fixed mortgage. Further on in this article, we will highlight the opportunity cost of that higher payment to show you how a 15 year fixed robs you of creating long term wealth.

Under the CFPB’s QM/ATR rule, pretty much any mortgage today will not carry a prepayment penalty. This means you can make additional principal payments on your loan, regardless of the loan term. Going back to our scenario, let’s take a 30 year fixed loan with an interest rate of 3.560% and a PI payment of $941.83/mo. If you were to make an additional monthly payment of $474.92/mo, your payment would be $1,416.75/mo, which matches the 15 year fixed payment. If you were to make this additional $474.92/mo prepayment, your 30 year loan would become a 16 year loan (plus 2 months). 

What about the life of loan interest?

Using our same numbers, the life of loan interest paid on a 30 year fixed mortgage is $130,874. The life of loan interest on a 15 year fixed mortgage is $46,831. At first glance, the interest rates savings on a 15 year fixed is $84,043. While this is true, we’re forgetting one critical piece of information, which is the difference in payment.

What if instead of paying an extra $475/mo towards your mortgage, you were to invest $475/mo at an 8% rate of return over 15 years? Your account balance would grow to $164,368! After 15 years, your 30 year mortgage balance would be about $131,205. Could you not then cash-out your investment and payoff your mortgage balance if you wanted to? Assuming long-term capital gains tax of 20% on the $164,368, you would still be able to payoff your mortgage balance ($164,368 x 20% = $33,873.60 capital gains tax, or $131,494 leftover to payoff the loan).

According to Investopedia.com “The S&P 500 index has returned a historic annualized average return of around 10.5% since its 1957 inception through 2021”. If we use a 10.50% average rate of return on $475 invested monthly, this would grow to $206,164 in your account balance. $206,164 minus $41,232 in est. capital gains tax ($206,164 x 20%) = $164,931. Once the mortgage account balance is paid off, you would still have an additional $33,437 leftover in savings.

Of course, your rate of return in the stock market is never guaranteed and we are discussing average rates of return here, but let’s take this a step further with another example.

Borrower A takes out a $208,185 mortgage at a 3.560% fixed rate for 30 years and invests $475/mo at an 8% rate of return for 30 years. After 30 years, the mortgage is paid off and borrower A has $707,921 saved for retirement and paid $130,847 in life of loan interest.

Borrower B takes out a $208,185 mortgage at a 2.790% fixed rate for 15 years. After 15 years, the mortgage is paid off, and Borrower B then starts investing their former mortgage payment of $1,416.75/mo in a retirement account earning 8% rate of return. After 15 more years of saving $1,416.75/mo, Borrower B would have $490,250 saved for retirement and paid $46,831 in life of loan interest.

Now let me ask you a question. Between Borrower A and Borrower B, which one would you rather be? Borrower B did save $84,043 in interest payments compared to Borrower A, but do you think that matters when we’re talking about an extra $217,671 saved for retirement? Even though Borrower B started saving MORE than Borrower A on a monthly basis, the fact that Borrower B started later in life cost them time, which is a very important factor when saving for retirement. Unfortunately, you can’t recapture the time once it’s lost. The rule of 72 is an easy way to figure out how long it takes your money to double based on a rate of return. Simply divide 72 by your rate of return to determine how long it takes your money to double. For instance, an 8% rate of return means your money will double every 9 years. It is because of this reason, Borrower B doesn’t have as much saved as Borrower A for retirement. Borrower B essentially missed out on almost two extra doubling periods, which ultimately lead to the difference between $490,250 saved for retirement and $707,921 for Borrower A. Assuming Borrower A and Borrower B continue saving $475/mo and $1,416.75/mo (respectively) for an additional 5 years before retirement, Borrower A would have saved a grand total of $1,089,594 while borrower B still would only have saved $834,495 using an 8% rate of return.

Do your future self a favor, and use this lesson to create more wealth for your retirement. The 15 year fixed mortgage looks good on the surface, but once you dive into the math and reasoning behind WHY a 15 year gets paid off earlier, it’s clear to see why the 15 year fixed mortgage can rob American families of their wealth.

Seth Wilcock, Resolute Lending, Independent Mortgage Brokers and/or it's affiliates does not provide financial planning, investment, tax, accounting or legal advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, financial planning, investment, tax, accounting or legal advice. You should consult your own financial planning, investment, tax, accounting or legal advisers before engaging in any transaction.