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15- or 30- Year Loan?
By: Bernice Ross

Owning your primary residence free and clear is one of the best ways to protect yourself from financial disaster. If you bump into difficulty, you can refinance the property or rent it out to generate income. After you reach the age of 62, you can obtain a reverse mortgage where the lender pays you a fixed payment each month in exchange for receiving the title to the property when you die. One of the quickest ways to reach this goal is to take out a 15-year mortgage rather than a 30-year mortgage.

For example, assume that you buy a property and you take out a $100,000 loan at six percent fixed rate. You are in the 25 percent tax bracket. If you paid off the loan in 15 years, your monthly payment would be $843.86. Your total payments would be $151,894 ($100,000 in principal and $51,894 in interest). Now compare the same scenario, except this time you pay off your loan in 30 years rather than in 15. Your monthly payment is $599.55 per month. Your payments will total $215,838 ($100,000 in principal and $115,838 in interest.) The interest savings between paying off your loan in 15 vs. 30 years is $63,944.

Based upon this data, it seems to make sense to pay off the mortgage sooner rather than later. Itís not that simple, however. Since the IRS allows most people to deduct their mortgage interest, you must take into account how much that deduction saves you on income taxes. A rough approximation would be that at the 25 percent bracket, you would save $12,974 (.25 X $51,984) in taxes on the 15-year loan. This means your actual out-of-pocket interest expense for the 15-year loan is $38,920. For the 30-year loan, you would save approximately $28,960 in taxes. Thus, your actual interest expense after taxes would be $86,878. Thus, the savings between the two loans ($86,878 - $38,959) is $47,919 in interest expense rather than $63,944.

Another variable in this equation is the rate of appreciation. The numbers in this example actually underestimate the value, since appreciation normally increases on the value from the preceding year. A good analogy is that these examples are comparable to simple interest comparisons when appreciation more closely resembles compound interest.

Assume that the value of your home ($100,000) appreciates with the rate of inflation. Taking the inflation data for the last nine years and averaging it (from Inflationdata.com), the current annual rate of inflation since 2000 has been 2.898 percent. If you were to assume that the inflation rate will hold steady for the next 15 years and that your houseís value will increase at the inflation rate, your house would experience a 43.47 percent increase in value (2.898 X 15 years). In other words, after 15 years, your house will have appreciated by 43.47 percent or $43,470. Projecting out to 30 years, that number is 86.94 percent. This means that your $100,000 house would have appreciated by $86,940.

The $843.86 payment on the 15-year mortgage will amortize a 30-year loan of approximately $140,650 for 30 years. Using the same appreciation rate as above, if you own the $140,650 house for 15 years, it will appreciate $61,141 and be worth $201,791. If you own the property for 30 years, it will appreciate $122,281 and be worth $262,931.

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