How do I choose between a 15 year mortgage and a 30 year mortgage? Does the F.I.R.E. philosophy change the game?
How the Game is played
In general, the more you can invest in high growth rate index funds the better off you are. This is especially true if you are a standard investor with a 30 to 40 year investment horizon. In the standard timeline you are likely better off taking a 30 year mortgage and investing the rest, than you would be taking a 15 year mortgage and investing less while you pay off the mortgage. In a long timeframe strategy, the compounded growth of the extra investments early on usually beats paying off the house early and then catching up investments after the mortgage is paid. This assumes that you will end up with a paid off home in either case since your horizon is long.
Breaking the game
But what if you are a F.I.R.E. devotee? You are already planning to break the game in a couple important ways. First you are probably decreasing expenses and lowering your target F.I. number, while increasing investments. This results in a significantly shorter accumulation phase allowing for early retirement. So how does this affect the mortgage calculation?
The power of less
When you reduce your investing timeframe, a couple things happen. You have less time to save, and less time to allow for compounding growth to do your work for you. This means that reducing expenses becomes more important in the F.I.R.E. toolbox because growth has become a less effective one. So if you have a 10 to 15 year timeline ahead of you it may make more sense to get the 10 or 15 year loan. The reason this could work is that it will cut your expenses by a substantial percentage. Once the house is paid for, your housing expenses go way down. This in turn reduces your target F.I. number. In a short timeframe strategy the reduction in expenses when you retire your mortgage can more than offset the decreased investment rate due to increased mortgage payments.
Doing the math
This is a subject where there is no single answer that works for everyone. You will have to do the math. In my case the difference between a 15 and a 30 year loan would be about $800 dollars a month. This money could be invested and would make a pretty significant difference in my projected portfolio balances over the next 10 years. If I instead keep my 15 year loan and use that money to pay off my home in 10 years (I’m 5 years in to my 15 year loan.) then I will hit F.I. at about the same time as I pay off my loan. If I refinance to a 30 year loan and invest the difference, then I will have more in investments by year 10 but I won’t be F.I. till about year 12 or 13 due to the continuing mortgage expenses. Less is more. So for me, paying off my house could save me two or three years of work.
F.I.(ish) P.E.E.
What about super early retirement with a pivot? This might change the equation again. Since I won’t likely be able to pay off my mortgage in the next 5 or 6 years, if I want to pivot early I might want to refinance to a 30 year mortgage at some point to bring expenses down, or maybe just refinance to another 10 or 15 year mortgage once the balance is cut way down. Either that or hold off on the pivot till I can pay off the mortgage. House hacking is also a serious consideration. I could move to a duplex and rent the other unit to reduce some of my housing costs. There are a lot of options. The main point is that for F.I.R.E. adherents, reducing expenses can be more powerful than pumping more money into investments. This is especially true for big ticket items like housing. Of course every circumstance is different, so make sure to do your own calculations.
Travel and moving
If your pivot will involve a lot of travel, or you plan to move a couple times over the next 10 years or so, then you may want to forgo a mortgage altogether and just rent. Financing and closing costs can easily reverse the value calculation on home ownership. You can’t pay 8-10% of the home value to banks and real estate agents every five years and still expect to come out ahead. If you do, then you are very lucky. Those realtor and banking fees represent three or four years worth of equity accumulation. So each time you move, you are likely pushing your F.I. date out another couple years. Downsizing and/or house hacking would of course help offset the damage done by paying all those fees. So math that stuff all to heck.
