Your home mortgage is likely to be the largest single financial transaction you'll be involved in personally, so what kind of mortgage you take on will have an enormous effect on your financial well-being. Whether to go for the 15- or 30- year option is a complex proposition with many aspects to consider. The tax implications are just one of them.
15- vs 30- Year Mortgage Basics
These loans are exactly what the name suggests. A 15-year mortgage is paid off after 15 years of payments. Although there are exceptions, a 30-year mortgage for which you qualify will have a higher interest rate than a 15-year mortgage under the same conditions. Between the shorter payoff period and the lower interest rate, this means paying significantly less interest on a 15-year mortgage than on a 30-year option, which means less of a tax deduction.
Somebody with good credit might expect a 3 percent interest rate on a 15-year loan and a 4 percent rate on a 30-year loan for the same house. For a $200,000 home, the interest on the 15-year mortgage would total $48,609. A 30-year option would cost $103,554 in interest -- more than twice as much over the life of the loan.
Homeowners in the United States can deduct normal mortgage interest on their primary home from their incomes when filing their taxes. This means that you can expect a much larger tax deduction from a 30-year mortgage than from a 15-year mortgage. This deduction applies only to the home you live in, not to investment homes or rental properties.
A Matter of Scale
While it's true that the longer mortgage option represents greater tax savings, those savings are unlikely to equal the difference in interest paid between the two options. For example, if you are in the 25 percent tax bracket, your deduction would mean paying about $25,000 less in taxes over 30 years than you would without the loan. The 15-year option would save about $12,000. The $13,000 in extra tax savings from the longer loan is less than one-quarter of the difference in interest costs.
The "Wiggle Room" Method
This option represents a compromise between the 15- and 30- year mortgage option, in which you sign for a 30-year loan with no early payment penalties and make payments sufficient to "kill" the loan in 15 years. This allows you to save on interest by paying extra principal every month while having the flexibility to scale back on payments if you have a hard financial month. You also pay more interest each year than with a 15-year mortgage, meaning more tax savings than with the shorter loan.
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