While there are seemingly innumerable types of mortgages available today, the vast majority of homeowners still find the right fit with either a 30-year or 15-year fixed rate mortgage loan. The 30-year fixed mortgage itself is a standard that countless Americans have chosen on their path to home ownership. In fact, according to the Mortgage Bankers Association, 86% of people applying for mortgages in February 2015 opted for 30-year loans.
However, because physicians have strong purchasing power, the lower interest rates that accompany a 15-year loan can be quite attractive, which brings us to the ever-present question: 30-year or 15-year.
This post takes a specific set of assumptions that are characteristic of physicians, limits the audience to one (you!), and provides a more definitive answer to this question.
INCLUDE INVESTMENT AS A HOME-BUYING GOAL
First let us prioritize our goals.
Building equity is a common home-buying goal, but how important is it? If you plan to move out of your home in five years or less, then a 15-year mortgage is more attractive due to its rapid rate of equity. This is especially true for a 15-year loan in a market where prices are flat, or experience slow growth like small towns or rural areas.
If, however, you live in a growing market where houses appreciate quickly, then equity can be gained from the growing market value of the home, making the lower payments on the 30-year loan more attractive.
For the purposes of this post, let us assume an average market where equity is not the top priority, and approach this question from an investment mindset. With that mindset, we can explore which option leaves us in a better long-term financial position where the variables are equal. A simple and effective way to do this is to look at the financial position at the end of 30 years with the critical assumption that we have enough discipline to invest the difference between the payments of the 30-year loan, and 15-year loan.
PHYSICIAN HOME LOAN ADVANTAGE
Because physicians have such high income potential, they typically qualify for some convenient benefits from lenders. Amongst many things, these benefits can include waiving the down payment on a home and forgoing costly Primary Mortgage Insurance. We will use these assumptions, and the 2015 average interest rates, for home mortgage loans in our comparison between the two options.
The average interest rate for a 15-year fixed rate loan was 3.17%, and 3.94% for a 30-year fixed rate loan. For a $400,000 home with these numbers, your minimum monthly payment for the 15-year mortgage loan would be $2,795.15, while the minimum payment for the 30-year mortgage loan would be $1,895.85. Thus the difference between these premiums would be $899.30 per month.
Now, let's crunch those numbers and see what they tell us:
Obviously, the total interest paid on the 30-year loan greatly exceeds that of the 15-year loan. But what we are really looking for is the amount of returns that would come from investing. The options are compared in two different ways.
First, we want to know which option generates more cash in a controlled environment for the specified time period. For this, we will assume a simple 7% annual return.
Next, we want to see how the opportunities and risks of volatility affect the performance of the two options. So for the second comparison, we will use the actual return rates of the S&P 500, with the final investment for both options occurring at year's end, 2014.
That calculation looks like this:
It would seem in this scenario that taking the 30-year loan and investing the difference would leave you in a far better financial position at the end of 30 years when compared to the 15-year loan. At this point in the comparison, many people incorrectly subtract the interest paid from the returns, but that is unnecessary because the expenses are the same in both scenarios (360 payments of $2,795.15).
OTHER ADVANTAGES OF A 30-YEAR LOAN
There are a few more things worth noting about the 30-year loan.
In a situation where you would rather have the cash than make an investment, you have the flexibility to do so with the lower minimum payment. In addition, physicians should aim to keep fixed expenses as low as possible. The 15-year mortgage would require a larger portion of a physician's net income in the event of a disability or emergency, and could potentially cause you to default on future loan payments if such an event occurred. This option also spreads your investing over a greater length of time, allowing you to absorb the ebbs and flows of the market more easily and effectively than if you were to invest over a shorter period of 15 years.
We understand that some physicians may operate under a different set of assumptions than the defined scenario articulated above. However, we find this to be a common question from the physicians with whom we meet, and normally find the mathematical outcome is similar for each.
Our hope is that this will give you an analytical, data-driven perspective rather than vague, more subjective opinions you typically find when consulting with Google about the best way to handle your mortgage.