Mortgages & Creative Financing

Why a 30-Year (NOT 15-Year) Mortgage Gives You a Better Shot at Building Wealth

Expertise: Real Estate News & Commentary, Real Estate Investing Basics, Mortgages & Creative Financing, Personal Finance, Personal Development
72 Articles Written

It’s a question that is frequently asked by homeowners and real estate investors around the nation:

Want more articles like this?

Create an account today to get BiggerPocket's best blog articles delivered to your inbox

Sign up for free

Should I go with a 30-year mortgage and have a lower monthly payment, or should I go with a 15-year mortgage and pay off the loan much faster?

And the answer, as is so often the case, is always: it depends.

However, if we rephrase the question, expressing a goal, we can certainly come up with an answer to help homeowners and investors understand which type of loan IS preferable.

So, for the purposes of this article, we will frame the questions like this:

If my goal is to give myself the greatest statistical probability of building more wealth over time, should I go with a 30-year mortgage and have a lower monthly payment, or should I go with a 15-year mortgage and pay off the loan much faster?

The short answer to this question is this:

Go with the 30-year mortgage, and especially so in this current market of low interest rates.

Related: Mortgage Questions, Answered: How to Qualify For & Obtain Home Financing

If you are a bit of a math nerd and want some statistical analysis behind why the 30-year mortgage is superior to the 15-year (or even shorter loan periods), read on.

cash-on-cash-return-real-estate

Why a 30-Year Mortgage is Better Than a 15-Year Mortgage

I created a spreadsheet to model out the logic behind why a 30-year mortgage is advantageous to a 15-year mortgage — which can be downloaded here. This spreadsheet, like any financial model, is based on some assumptions. Please bear in mind that this analysis is for a rental property, but the conclusions are similar for homeowners.

Here are some of the key assumptions that go into this model:

  • I assume that property prices and rents will increase with inflation at about 3.4% per year.
  • I assume that interest rates are about 3.5%.
  • I assume that expenses related to maintaining the property will be about 50% of the rent the property would collect.
  • I assume that rents are about 1/10th of the value of the property.
  • I assume that the stock market produces 11.5% annual returns.

Some or maybe all of these assumptions might be things that you disagree with. I recognize that there is no consensus for those assumptions and invite you to go ahead and download my model and play with them. It’s possible that some cases, changes to the assumptions in this model might result in situations that favor the 15-year loan, though I expect those cases to be the exception, not the rule. Note that I do not make assumptions for the following:

  • Differences in interest rates: This might favor the 15-year loan, as 15-year loans might have lower interest rates.
  • Tax implications: For homeowners and real estate investors, interest is tax deductible. This might favor 30-year loans further, as the mortgage interest is partially offset.

In this model we compare three scenarios:

  1. Buying a property with 20% down on a 30-year loan
  2. Buying a property with 20% down on a 15-year loan
  3. Buying a property with 100% cash and no loan

Let’s compare some of the key metrics going on over 30 years in these two charts:

CFROEOK, so let’s point out something right off the bat. Real estate, on average, performs worse than the stock market when bought completely with cash. It is only with leverage that average real estate returns begin to exceed the returns offered by stocks over a long period of time. You can see that in year one, both a 30-year and a 15-year loan produce high average returns for investors. This is because the property is at its most leveraged point during this timeframe.

Related: Are Extra Mortgage Payments Worth It? A Look at the Numbers

The reason for this is that leverage amplifies returns. If you buy a house for $100,000 in cash and it increases in value by $10,000, you’ve made 10% on your money. If you buy a house for $100,000 with a down payment of $20,000 (a loan of $80,000) and it increases in value by $10,000, you’ve made 50% on your initial $20,000 investment.

Over time, as you pay down the loan, and as the property appreciates in value with inflation, your leverage decreases. To continue our example, if in 10 years you’ve paid down 25% of your $80,000 loan (balance is now $60,000), and the property has increased in value to $120,000, you are now leveraged at 50%. As your leverage decreases, so does your return on equity.

So our first chart now makes sense — the return on equity is lower for less leveraged real estate, on average. You pay down the loan faster on a 15-year mortgage and therefore have less leverage each year than with the 30-year loan. Therefore, your return on equity is lower with a 15-year loan than a 30-year loan.

If you look closely at the graph, you’ll notice that the return on equity for the all-cash investor increases over time and that once you pay off the loan in year 15 for the 15-year loan investor, the returns also increase (that’s the bend in the red line in the graph).

The reason for this is that this model assumes that all excess cash flow is reinvested, in this case in the stock market. An investor with a 15-year loan will produce less cash flow than either the all-cash investor or the investor with the 30-year note for the first 15 years and therefore will not be able to reinvest that cash flow.

It is that reinvestment of cash flow that separates the 30-year note investor from the 15-year note investor. The investor with a loan term of 30 years will have lower payments, will generate more cash flow up front, and will be able to reinvest those cash flows sooner than the investor with a 15-year mortgage. Only for a brief snapshot in time — a handful of years after the 15-year mortgage is paid down — will one see higher cash flow in the case of a 15-year note.

This is why the investor with the 30-year note has both more net worth and more cash flow at the end of the period we look at in this study. The reinvested cash steadily compounds to build a portfolio that appreciates with the stock market and spits out regular dividends.

Over time, the effects of more leverage and greater cash flow compound to the extraordinary advantage of the investor with the 30-year loan:

NW

Conclusion

Does this analysis necessarily mean that a 30-year loan is right for you? Like I mentioned at the beginning of this article, the answer to that question is “it depends.” There are many reasons why a 15-year loan might be better for you than a 30-year loan. Maybe you prefer to be debt-free as soon as possible. Maybe you don’t think you have the discipline to reinvest the cash flows as soon as you receive them.

How you view your life and your personal finances is completely up to you.

But if your goal is to choose the financing that will help you create as much wealth as possible over time, then a 30-year loan is likely to be a better bet for you than loans of shorter timeframes.

Just remember, even with a 30-year loan, you begin to deleverage to the point where you are no longer earning returns in significant excess to those historically produced by stocks, on average, about 7-10 years into the loan cycle.

It’s important to revisit your goals every few years — you might find that it’s time to refinance and buy more property, or you be content to coast on the cash flow you’ve created already, acknowledging the possibility of declining overall returns.

Looking to set yourself up for life as early as possible and enjoy time on your terms? Scott Trench’s new book Set for Life is now available! Whether you’d like to “retire” from wage-paying work, become less dependent on your demanding nine-to-five, or simply spend time doing what you love, Set for Life will give you a plan to get there. This isn’t about saving up a nest egg. It’s not about setting aside money for a “rainy day.” Set for Life is an actionable guide that helps readers build the accessible wealth they need to achieve early financial freedom.

[Editor’s Note: We are republishing this article to benefit newer reader to this blog.]

Investors: Do you agree with this assessment?

Feel free to disagree — just let me know your rationale!

Scott Trench is a perpetual student of personal finance, real estate investing, sales, business, and personal development. He is CEO of BiggerPockets.com, a real estate investor, and author of the ...
Read more
    Deanna Opgenort Rental Property Investor from San Diego, CA
    Replied over 2 years ago
    If you are living off the income it’s part investment, part annuity. As far as the appreciation numbers with the 1031 exchange returns, won’t that sort of depend on how good an investment the million dollar property is and which 30 years? A $1m class B middle-class multi-family is likely to behave very differently than a new $1m mansion in Texas.
    Shaun Reilly Landlord and Rehabber from Newton, Massachusetts
    Replied about 2 years ago
    I think what usually misses the mark in all these 15 vs. 30 year type articles is that different investors have different goals and priorities. NOBODY thinks you will acquire more properties faster and with higher ROI, ROE, IRR ect… when buying with all cash or large down payments with traditional loans with shorter amortization periods. People doing that are looking at risk and maximizing cashflow in the short term (all cash) or mid term (payoff debt ASAP). So 15 year loans make no sense for the people that are willing to take a higher level of risk and are driven to maximize their percentage returns by all the various measures as quickly as possible. This question is only for the investor that is looking to acquire a small to medium portfolio (I’m calling medium several dozen residential units in 1-4 family buildings, as this also doesn’t apply at all once you go commercial). Now all that being said I would ALWAYS take the 30 year loan. Why? Because it is less risky than a 15 year loan. A smaller payment means you can weather a storm easier than if you are required to make a larger payment. Now after THAT being said there is no reason not to work to jettison the debt as quickly as possibly if you would like. Now there IS the inherent benefit of getting a lower rate on a 15 year loan. (As and aside I find it interesting that Scott makes a LOT of assumptions in his analysis but doesn’t take into account the difference in interest rate. This isn’t an assumption it is a fact. The actual rate you put in can be an assumption [though the current rates are simple to get] but the fact there will be a difference isn’t unlike an appreciation rate or returns on the stock market etc.) As other people have said in different comments you can just make the 15 year payment and pay the loan off faster. It won’t be 15 years but it won’t be much longer. As of today if you use the current rates (about 4.5% on a 30 and about 4.0% on a 15) you would payoff the 30 year loan with the 15 year payments in just under 15 years and 9 months. So why advocate for the longer term when you will end up paying about $13K more on a $200K loan? Well mostly because you can think of that as the premium paid on a 30 insurance policy for an economic emergency. If you have a 15 year fixed you HAVE to make the higher payment with the 30 you can always make just the regular payment (in that $200K case can lower the payment by about $465 a month). So if you have a prolonged vacancy or maybe lose you JOB or something else you can temporarily cut back to hoard current cash until things turn around.
    Cory Binsfield Financial Advisor from Duluth, MN
    Replied about 2 years ago
    Awesome spreadsheet Scott! I’m a huge fan of locking in a historic low rate on a 30 year mortgage and buying ten decent cash flowing rentals as soon as you can. The extra cash flow allows you to weather storms like the last housing crash or save for the next down payment. Like others have pointed out, you can decide to pay off your loan sooner by simply kicking in extra principal payments once you decide to delever the portfolio. I’d like to point out that there is a big difference between average annual returns and compounded returns. It looks like you arrived at the 11.5% return by averaging the data set? The true return is based upon the growth of $100.00 from 1928-present. Due to volatility of the stock market, the compounded return is lower. The compounded return is 9.8%. Here is the calculator https://dqydj.com/sp-500-return-calculator/ If you ever want to geek out on returns, this is my favorite site for all things financial including S&P 500 and Dow calculators. Sadly, the vast majority of investors will never get this return unless they buy the S&P 500 index fund and never get scared out of it. Most investors buy active funds or individual stocks. Even with the lower return, the 30 year investor wins. Worse, why tie up equity in a 15 year mortgage when it can be reinvested at a higher rate?
    Nelson Diaz
    Replied about 2 years ago
    I think a 30 years mortgage is best. Over all, using the technique in this video that let you reduce your mortgage less than 15 years and reduce drastically your interest payment. You can skip the pitch and go directly at minute 24. Copy and paste