Why we chose a 30 year mortgage when we can afford a 15 year

When we first went and talked with our mortgage broker he had suggested that based on our income and financial responsibility that we should take out a 15 year mortgage rather than a 30 year. At first we were both pretty gung ho about it because we could easily afford a 15 year note. However, once I started crunching the numbers to see how exactly our budget would look I quickly changed my mind. The mortgage note alone wouldn't be an issue to cover, but when you add in all the other expenses including insurance, taxes, full maintenance costs, increased utilities and furniture, the monthly outlay quickly rose from just the 15 year note. Adding to the risk is that my job is currently stable but far from being as stable as my wife's job as a teacher. If you've studied the oilfield, or just paid some attention to the news, over time is a very boom and bust industry. 

The numbers and risks associated with having a less than stable income led us to change to a 30 year mortgage. Reaching financial independence is all about cash flow and while we will have the mortgage payment for twice the time, the cash flow becomes easier to manage. The 15 year mortgage was going to give a payment of $1,282.05 while the 30 year gives a payment of $911.84. The difference seems small enough at just $370.21, but when you consider that our main source of passive income after reaching financial independence is going to be dividend income that would require almost $127k invested at a 3.50% yield just to cover the difference. Not to mention that should I lose my job completely and can't find new employment the costs listed above would run about 90% of my wife's paycheck and our passive income based on the 15 year but 80% based on the 30 year. Neither one is optimal but the 30 year is a little bit better.

Our plan for paying off the mortgage is to invest the difference of $370.21 for the first 15 years which will give us many more options along the way and free up our monthly cash flow for future savings. Let's define a few assumptions to see where we could be at financially at the 15 year mark by investing the difference. First is the monthly investment of $370.21, considering we're both good at budgeting/keeping track of our finances, this won't be going towards other uses. Second I'll assume that I can return an average annual return of 8% and since I'll be using a dividend growth strategy I'll assume a 3.25% average current dividend yield. You can see the calculations in the following Google spreadsheet or access the full screen version here.



After just 1 year our portfolio will be worth $4,609.09 and be churning out $149.80 in annual dividends or $12.48 per month. That would cover 1.37% of our 30 year mortgage payment. Five years out and our portfolio value would be $27,201.87 and spinning off $884.06 in annual dividends. That's good for $73.67 per month which would cover 8.08% of the mortgage payment. Going to 10 years out and the portfolio value would be $67,728.45 and paying out $2,201.17 in annual dividends or $183.43 per month which would cover 20.12% of the mortgage payment. But the 15 year mark is really what matters to determine whether this was the right move. At year 15 the portfolio would be valued at $128,106.81 and churning out $4,163.47 in annual dividends. While the monthly dividend income is only $346.96 and covering just 38.05% of the mortgage payment the good news is that our mortgage balance would be $117,228.23. Our portfolio balance would actually cross our mortgage balance at the 14 year and 3 month mark, or the 171st payment.

So at the 15 year mark we'll have a few options. We can either liquidate the portfolio and payoff the remaining balance and walk out almost $11,000 ahead or we can leave the portfolio intact and it continue to compound and grow. As of now I'm leaning towards letting it continue to compound but we're still 15 years away from making that decision. It will all depend on what the rest of our financial picture looks like at the time. If we can still live comfortably by liquidating the portfolio and paying off the balance then that's what we'll do, but if we need the dividend income then we'll probably let it keep growing.

Just some interesting tidbits from crunching the numbers. Assuming 3.00% annual inflation, the 30 year mortgage payment would be equivalent to just $581.74 2013 dollars after 15 years and $371.14 2013 dollars after 30 years. If we continued to invest the difference between the two payments it would take 24 years and 7 months for our dividend stream to fully cover the mortgage payment and we would have a portfolio value of $338,760.02. After 30 years the dividend stream would be $1,494.31 which would be 164% of our mortgage payment with a portfolio value over $550,000. 

Even though interest rates have risen over the past few months I think a 30 year mortgage is still very attractive assuming that conservative estimates of your investment opportunities can return 7-8%. Once the interest rates start to approach or surpass 6% the numbers just don't work out as well because you can take a guaranteed 6% return by paying down the mortgage or take a riskier move by investing in the markets to gain an extra 1-2% on average.

Would you go with a 15 year or a 30 year mortgage?  Did you run the numbers before making the decision if you currently have a mortgage?  Surprised by the results?