Editor’s note: This article was first published in August 2022, when inflation was high and rising; its inflation argument reflects that moment.
In the previous article we looked at the best way to pay off a mortgage faster, comparing one large extra payment a year with small monthly overpayments. This time we are going to break, in a way, with a common belief in personal finance. People logically assume that when choosing between a 15-year and a 30-year fixed-rate mortgage, the best option, if you can afford the higher payments, is the 15-year one: you pay off the mortgage in half the time and also save a large amount of money in interest.
That line of thinking makes some financial sense. But the 30-year mortgage may well be the best option for most people, because it offers many more advantages than its shorter-term sibling.
Let me be clear that every person and every situation is different, so it is up to you to decide whether these advantages fit the way you think. Here we only focus on the most logical side of financial education. In fact, as we will see below, the smartest move may be to take out a 30-year mortgage and plan on paying it off in 15.
Why a long-term mortgage is better than a short-term one
Lower monthly payments
This is without doubt the biggest advantage. A 30-year mortgage has lower monthly payments, which leaves you with spare money you can use however you see fit. That said, someone who today has no trouble paying a 15-year mortgage of €1,000 a month, and who prefers that to a 30-year mortgage of €500 a month, should analyse their situation very carefully.
Most home repossessions happened to people who, on the day they signed their mortgage, thought they could keep up with the payments. Over the years their situation changed and they found they could no longer meet them. That is why, even if you can afford to pay twice as much for your mortgage today, you should ask yourself whether your finances are ready even for unlikely setbacks. Obviously, if you have 10 million euros saved, this article is not for you: in your case it clearly pays to clear the mortgage as quickly as possible.
More flexibility
When your finances are healthy, you will always have the option of making extra payments to reduce the mortgage principal. In other words, if you are paying €500 a month, you can always pay double for a few months or pay off €5,000 at any time.
If you have a 15-year mortgage with €1,000 monthly payments, however, going the other way is quite difficult. If you suffer a financial setback and cannot keep up with the high payments, you cannot tell the bank you will only pay €500 a month for the next year. All you can do is ask to refinance the mortgage, and that will not always be granted, especially if you are asking because your finances have got worse.
In short, with a 30-year mortgage you always have the option, though not the obligation, of paying it off in 15 years without a penalty and saving much of the interest. The reverse (paying a 15-year mortgage over 30 years) is not possible.
See also: What leads to poverty, according to T. Harv Eker, author of Secrets of the Millionaire Mind
Either way, a longer-term mortgage with comfortable, low payments considerably reduces your financial vulnerability.
Greater capacity to save
In financial education we always say you should put off taking on a mortgage for as long as possible, because a mortgage limits your ability to save and invest to some extent. A high monthly payment limits it even more. At the same time, mortgage interest rates are not as high as those on other kinds of loans. So when we say you should be debt-free before you invest, we tend to leave the mortgage out of it, since it is not hard for an equity investment to beat the interest you pay on your mortgage.
So, once again, lower payments leave us more money to save and invest, without losing the option of making extra payments whenever we see fit.
Bigger tax deductions
This should never be the reason for choosing a 30-year mortgage over a 15-year one. It would be like agreeing to pay more interest in exchange for a tax deduction, that is, spending one euro to save one cent.
However, if you add these tax deductions to all the points above, offsetting the interest you pay with them (for those who can claim them) is not such a crazy idea. In fact, they roughly balance out. In absolute terms you will obviously pay more in interest than you deduct, but perhaps the difference is not as big as you imagine. Again, you have to take the previous points into account, as well as the next one.
A hedge against inflation
If you have a fixed-rate mortgage, you can count on inflation eroding the value of the euro and the dollar over time. That means the payments you make in the last 10 or 15 years are actually worth less than they were when you took out the mortgage. The counterargument is that the early years of a mortgage are when we pay the most interest and repay the least principal. Even so, we come back to the fact that you have to add in the advantages from the previous points.
And when inflation gets out of control, the euros we borrowed are, in the long run, repaid with euros that are worth less than the ones we originally borrowed.
And yes, the faster inflation rises, the less sense it makes to pay off the mortgage early, when you can choose the peace of mind and comfort of smaller payments at your own pace, making capital repayments whenever you think it is a good moment.
See also: The best way to pay off your mortgage faster
Featured image: Alan Cleaver, CC BY 2.0, via Flickr.
