Coffee, tea or milk?  Capitalism has made consumer choices possible within every area of the American landscape.  We select from hundreds of brands of computers, cars, airlines, banks and more.  We choose between mortgage companies and mortgage products.

Even after we pick a product such as a fixed rate mortgage, there are even more considerations with regard to the mortgage term.  The choice of term may affect our long term economic plan as well as our short term consumer preference.

The difference between 30-year and 15-year fixed rate mortgages, easily the most popular consumer alternatives, are quite clear.  The 30-year allows the lowest payment and achieves the greatest tax advantage because a larger portion of the mortgage is dedicated towards interest.  The 15-year requires a larger payment, a greater portion of which is dedicated towards principal reduction and achieving the goal of rapid equity accumulation. Another advantage of a 15-year mortgage is it comes with a lower interest rate.

Here is an example for a $300,000 mortgage.

Type        Rate       PI Payment
30-year    6.00%    $1,800
15-year    5.50%    $2,450

*Note that these rates are hypothetical and the principal and interest payments are rounded. Not only will interest rates change over time, so will the spread between the mortgage alternatives.

Most consumers would prefer a 15-year mortgage. However, the higher payments are tough on family budgets and many may not qualify for the larger payment. Basically, the payment is more than 35% higher for a 15-year. Thus consumers choose the 30-year alternative the majority of the time.

However, we think consumers should not give up their dream of building equity.  Therefore, we have introduced another alternative into the equation.  This alternative is the 20-year mortgage.  Here are the numbers with a 20-year mortgage factored into the equation.

Type        Rate         PI Payment
30-year    6.00%     $1,800
20-year    5.75%     $2,105
15-year    5.50%     $2,450

With the 20-year mortgage you are increasing your payment 17% over the 30-year, or only about 47% of the increase you will experience with a 15-year mortgage.

Yet, if you look at the benefit you will receive, you are eliminating 10 years off the mortgage, which is two-thirds (66%) of the benefit of a 15-year alternative which saves 15 years of payments.

Total benefit?

Type        Total Payments    Payment Savings
30-year    $648,000              $0
20-year    $505,200              $142,800
15-year    $441,000              $207,000

 *Note:  Payment savings is from 30-year.

Thus, what this table tells us is that you are achieving approximately 70% of the payment savings of a 15-year mortgage with a 20-year, though your payment is increased by only approximately 47% as compared to a 15-year mortgage.

Increase in payment:

20-Year $305 per month
15-Year $650 per month

In addition, those consumers who are paying mortgage insurance — because they are putting less than 20% down, may achieve additional savings with 20-year and 15-year terms.

Want to build equity, but don’t want the onerous payment of a 15-year mortgage? The 20-year alternative may be just the mortgage alternative you are looking for.