Buying a home is a major event in our lives, and the excitement can easily overshadow the long-term financial commitment we’re about to make. We tend to view a mortgage much like a car loan and focus on the monthly payment, while overlooking the cost of the loan or total amount of interest that will be paid over the life of the mortgage.

One of the greatest costs associated with a mortgage is the interest that will be paid over the life of the loan. We analyzed the effect of interest rates on monthly payments and the total cost of the loan in a previous blog. Next, we’ll look at the effect of changing the mortgage duration or number of years that we’ll be paying the loan. The table below shows the change in the monthly payment and total interest paid as the time period for the loan changes.

The monthly payment decreases as the duration increases, and this tends to make people more comfortable with the longer mortgage. They don’t always consider the significant increase in interest that will be paid over the life of the loan.

Mortgage of $250,000, at 4.5% Interest, over Different Time Periods

Time                Monthly                     Total                            Total
Period              Payment              Interest Paid           Payback Amount
15 year            $1,912.48               $94,246.98               $344,246.98
20 year            $1,581.62             $129,589.62               $379,589.62
25 year            $1,389.58             $166,874.36               $416,874.36
30 year            $1,266.71             $206,016.79               $456,016.79

To highlight the differences, let’s compare just the fifteen-year and thirty-year mortgages, since they’re the most popular durations (shown below). The monthly payment for the fifteen-year mortgage is $645.77 higher, but the total interest paid over the life of the loan is $111,769.81 lower. There are also 180 fewer payments to make since it will be paid off in fifteen years instead of thirty. Remember, the principal (amount we borrowed) is the same ($250,000) in both cases. The difference is the amount of interest that will be paid.

                  Comparison: 15-Year and 30-Year Mortgage

Time                Monthly                     Total                            Total
Period              Payment              Interest Paid           Payback Amount
15 year            $1,912.48               $94,246.98               $344,246.98
30 year            $1,266.71             $206,016.79               $456,016.79
Difference         $645.77             $111,769.81               $111,769.81

To see the difference on a monthly basis, we can compare the mortgage amortization schedules. These schedules or tables list the amount of principal and interest paid and the balance of the loan on a monthly basis through the life of the mortgage. For a thirty-year mortgage, the amortization schedule will have 360 rows, since there are 360 payments. There are usually columns for the payment number, payment amount, the principle portion of the payment, the interest portion of the payment, and the balance remaining on the mortgage.

If property taxes and home owners insurance are paid by the lender (holder of the mortgage), they are usually not included on the amortization schedule. They are paid from a separate escrow (safe-keeping) account. The amount needed for the escrow account is added to our monthly payment, and the lender diverts that portion of the payment to escrow. When taxes or insurance are due, the lender pays them from that account. Since the amount needed for escrow is added to our monthly payment, we need to be sure that we understand the details of a mortgage that we’re considering. The monthly payments in our examples do not include these items.

For comparison, the two tables below show the first six months of the amortization schedules for the $250,000 mortgage. The first table lists the amounts for the fifteen-year mortgage, and the second table lists the amounts for the thirty-year mortgage.

The “current balance” column on the right is reduced faster for the fifteen-year mortgage since the principal portion of the payment is much larger. In six months, the balance on the fifteen-year mortgage has been reduced by $5,905.02. For the thirty-year mortgage (below), it has been reduced by just $1,993.89. The rest of the monthly payment went toward interest.

People refinancing their thirty-year mortgages often opt for a fifteen-year mortgage to reduce the total amount of interest paid and to reduce the principal balance more quickly. As we saw, this significantly increases the monthly payment because the loan isn’t stretched out across as many years. It also significantly reduces the amount of interest paid over the duration.

If we can opt for a fifteen-year mortgage the savings is considerable, and we build equity in our homes as the principle on the loan is paid down more quickly. The principle that is paid off on the mortgage, the larger the portion of the home we actually own. The downside is the increased monthly payment, and committing to a large monthly payment may not be possible or in our best interest.

Thanks for reading.