Project 1
15-year mortgage VS 30-year Mortgage, Homeownership Tenure, and Effective Mortgage
Interest Rate
Buying a house is usually the biggest investment an individual makes in the U.S, and most
people buy their houses with mortgages. Mortgages are an amortizing loan in which the principle
is gradually paid off and the periodic interests are calculated based the remaining principle. The
most common mortgage terms are 15 years and 30 years.
Table 1: Comparison of 15- and 30-year mortgages
Feature 15-Year Mortgage 30-Year Mortgage
Monthly Higher. You pay off the loan in half the time, so the Lower. The payments are stretched
Payment monthly payments are substantially larger. out over a longer term, making them
more affordable.
Interest Rate Lower. Lenders offer a lower interest rate for shorter Higher. Longer terms carry higher
terms, as there is less risk. interest rates.
Total Interest Significantly less. A shorter term and lower interest Significantly more. You will pay
Paid rate save you tens or even hundreds of thousands of interest for 15 additional years.
dollars over the life of the loan.
Equity Faster. A larger portion of your monthly payment Slower. In the early years, most of
Buildup goes toward the principal, building equity more your payment goes toward interest.
quickly.
Financial Less. Higher payments can put a strain on your More. Lower payments free up cash
Flexibility monthly budget, leaving less money for savings, flow that can be used for other
investments, or emergencies. financial goals.
Qualifying Can be more difficult. Lenders require a lower debt- Can be easier. The lower monthly
to-income (DTI) ratio to ensure you can comfortably payment makes it easier to qualify
handle the higher payments.
However, all the discussion about 15-year VS 30-year mortgages neglect two important factors.
The first factor is the expected homeownership tenure, which means how many years a
homeowner expects to live in a specific home before moving. The second factor is the effective
mortgage interest rate paid on the loan.
This project will explore how the above two factors add to the debate of 15-year vs 30-year
mortgages.
Now assume David is trying to buy a $300,000 house with a mortgage. The house mortgage is
$300,000 with 0% downpayment. Lenders will usually require some downpayment. However,
for the simplicity purpose, we will set the downpayment to be 0%. Ignore property tax, home
insurance, private mortgage insurance, and other costs, as these factors do not change the
implications of this project. Assume the interest rate by the lender is 6% for both 15-year and 30-
year mortgages. Actual 15-year mortgage rate is generally lower than the 30-year mortgage rate.
A lower 15-year mortgage rate only strengthens the implications of this project. For the
simplicity purpose, we will use 6% for both mortgages in this project.
Table 2 and 3 show the amortization tables for the 15-year and 30-year mortgages respectively.
Table 2: Amortization Table of the 15-year Mortgage
Cumulative
Annual Annual Annual Cumulative Principal Remaining
Year Payment Interest Principal Interest Paid Repaid Balance
1 30378.84 17653.83 12725.01 17653.83 12725.01 287274.99
2 30378.84 16869 13509.84 34522.83 26234.85 273765.15
3 30378.84 16035.75 14343.12 50558.58 40577.97 259422.03
4 30378.84 15151.08 15227.76 65709.66 55805.73 244194.27
5 30378.84 14211.87 16166.97 79921.53 71972.7 228027.3
6 30378.84 13214.73 17164.11 93136.26 89136.84 210863.16
7 30378.84 12156.09 18222.78 105292.32 107359.59 192640.41
8 30378.84 11032.14 19346.7 116324.46 126706.29 173293.71
9 30378.84 9838.89 20539.98 126163.35 147246.27 152753.73
10 30378.84 8572.02 21806.82 134735.37 169053.09 130946.91
11 30378.84 7227.03 23151.84 141962.37 192204.93 107795.07
12 30378.84 5799.06 24579.78 147761.43 216784.71 83215.29
13 30378.84 4283.04 26095.8 152044.47 242880.51 57119.49
14 30378.84 2673.51 27705.33 154717.98 270585.84 29414.16
15 30378.84 964.71 29414.16 155682.69 300000 0
Table 3: Amortization Table of the 30-year Mortgage
Cumulative
Annual Annual Annual Cumulative Principal Remaining
Year Payment Interest Principal Interest Paid Repaid Balance
1 21583.83 17899.77 3684.03 17899.77 3684.03 296315.97
2 21583.83 17672.55 3911.25 35572.35 7595.28 292404.72
3 21583.83 17431.32 4152.51 53003.67 11747.79 288252.21
4 21583.83 17175.21 4408.62 70178.88 16156.41 283843.59
5 21583.83 16903.29 4680.54 87082.17 20836.92 279163.08
6 21583.83 16614.6 4969.2 103696.77 25806.15 274193.85
7 21583.83 16308.12 5275.71 120004.89 31081.83 268918.17
8 21583.83 15982.71 5601.09 135987.6 36682.95 263317.05
9 21583.83 15637.26 5946.57 151624.86 42629.49 257370.51
10 21583.83 15270.48 6313.32 166895.37 48942.84 251057.16
11 21583.83 14881.11 6702.72 181776.45 55645.56 244354.44
12 21583.83 14467.68 7116.12 196244.16 62761.68 237238.32
13 21583.83 14028.78 7555.05 210272.94 70316.73 229683.27
14 21583.83 13562.79 8021.01 223835.73 78337.74 221662.26
15 21583.83 13068.09 8515.74 236903.82 86853.48 213146.52
16 21583.83 12542.85 9040.98 249446.67 95894.43 204105.57
17 21583.83 11985.21 9598.59 261431.88 105493.02 194506.98
18 21583.83 11393.19 10190.61 272825.1 115683.63 184316.37
19 21583.83 10764.66 10819.14 283589.76 126502.8 173497.2
20 21583.83 10097.37 11486.46 293687.13 137989.23 162010.77
21 21583.83 9388.92 12194.91 303076.05 150184.14 149815.86
22 21583.83 8636.76 12947.07 311712.81 163131.21 136868.79
23 21583.83 7838.22 13745.61 319551 176876.82 123123.18
24 21583.83 6990.42 14593.41 326541.42 191470.23 108529.77
25 21583.83 6090.33 15493.5 332631.72 206963.73 93036.27
26 21583.83 5134.71 16449.12 337766.46 223412.85 76587.15
27 21583.83 4120.17 17463.66 341886.63 240876.48 59123.52
28 21583.83 3043.05 18540.78 344929.65 259417.26 40582.74
29 21583.83 1899.48 19684.32 346829.16 279101.58 20898.42
30 21583.83 685.41 20898.42 347514.57 300000 0
Your task is to answer the following questions. There is no right/wrong answer for each question.
Some questions are open-ended. As long as your answers have good reasoning, you will receive
the credit. Please answer each question with at least a short paragraph unless the answer is
straightforward.
This assignment is worth 75 points.
1. What is an amortized loan? (5 points)
An amortized loan is a kind of loan that is paid back through a variety of regular, equal
payments over a certain period of time. Normal payments consist of both interest (the
cost of borrowing money) and the principal (the amount borrowed). In the earlier months,
a greater proportion of each payment is to go towards interest. In later periods, payments
mainly reduce the principal balance. This is often set such that the loan is fully paid back
by then end of the loan term, with no remaining balance. Mortgages, car loans, and
personal loans are common examples of amortized loans that borrow will make equal
monthly payments until the loan is paid back in full.
2. Look at Table 2 and Table 3. What are the annual mortgage payments for 15-year and 30-
year mortgages? Which is lower and why? (5 points)
According to both Table 2 and Table 3, annual mortgage payment for the 15-Year
Mortgage equals $30,378.84, while the annual payment of the 30-Year Mortgage equals
$21,583.83. The annual payment of the mortgage is less for the 30-Year mortgage,
because the loan amount is paid back over a longer period of time (30 years compared to
15 years). As a result, the payment includes less principal and interest, in turn allowing
the monthly payment and the annual payment to be more affordable. The downside is that
the loan is for a longer time which equates to total interest paid for the loan being
substantially higher than the 15-Year Mortgage payment.
3. Look at Table 2 and Table 3. Although annual mortgage remains the same for the entire
length of the mortgages, does the interest portion of the annual mortgage payment
increase or decrease over the years? Why? (5 points)
The interest portion decreases over time for both types of mortgage. Since the interest is
calculated each year on the outstanding principal balance, and the outstanding balance
decreases as you pay down principal, the interest you are charged decreases each year as
well. With a fixed (Level) payment each year, a decreasing interest amount means that the
principal portion of annual payment will increase over time.
4. Look at Table 2 and Table 3, in Year 1 of the 15-year and 30-year loans, how much of the
annual payment goes to interest vs. principal? (5 points)
15-year mortgage loan (Year 1) — Annual payment: $30,378.84 Amount of the total
interest paid = $17,653.83 (≈ 58.11% of the total payment) Amount of the total principal
paid = $12,725.01 (≈ 41.89% of the total payment)
30-year mortgage loan (Year 1) — Annual payment: $21,583.83 Amount of total interest
paid = $17,899.77 (≈ 82.93% of the total payment) Amount of total principal paid =
$3,684.03 (≈ 17.07% of the total payment)
So in year one, the 15-year mortgage loan applies a much larger share (and dollar
amount) of the annual payment to principal than the 30-year mortgage loan, which is why
equity builds faster on the 15-year term.
5. Cumulative Equity. After 5 years, how much principal and interest has been repaid for:
a) the 15-year loan
b) the 30-year loan
(Use “cumulative principal paid” and “cumulative interests repaid” from the Table 2 and
3) (10 points)
a) 15-year loan (after 5 years) Cumulative interest paid: $79,921.53; cumulative principal
repaid: $71,972.70.
b) 30-year loan (after 5 years) Cumulative interest paid: $87,082.17; cumulative principal
repaid: $20,836.92.
6. In reality, most homeowners do not stay in their home for the entirety of the mortgages.
What are some of the reasons people move? (5 points)
Homeowners relocate for many personal and practical reasons. The most common
relocation reasons included job or career change (to move to a different office location or
to reduce commute time), family reasons (to be closer to aging parents, newly married or
having children and wanting more home and yard space, or to make a move post-
divorce), financial matters (down-sizing because of lowered monthly payments or to up-
size with an increase in income), space and lifestyle options (better yard space, home
office, or a different floor plan), school or neighborhood needs (better school systems,
safer neighborhoods, or different community amenities), health or aging (moving from a
two-story to a one level home, assisted living, or proximity to health care), or investment
or market-based (timing a selling to capture home-priced gains or moving to a different
market place). Oftentimes some combination of these factors exist in a single sale and
purchase transaction, which may explain why the terms of a long mortgage are unlikely
to coincide with the actual content of property ownership tenure.
7. Define the following term:
Effective Mortgage Interest Rate
= cumulative interest paid/(cumulative principle repaid * the number of years living in
the house).
Complete the following table for the 15-year mortgage. (10 points)
Effective Mortgage Interest Rates of the 15-Year Mortgage.
Number of years Cumulative Cumulative Effective Mortgage
Living in the house Interests paid Principle Repaid Interest Rate
1 17653.83 12725.01 138.73%
3 50558.58 40577.97 41.53%
5 79921.53 71972.7 22.21%
7 105,292.32 107,359.59 14.01%
9 126,163.35 147,246.27 9.52%
11 141,962.37 192,204.93 6.71%
13 152,044.47 242,880.51 4.82%
15 155,682.69 300,000.00 3.46%
8. Complete the following table for the 30-year mortgage (10 points)
Effective Mortgage Interest Rates of the 30-Year Mortgage.
Number of years Cumulative Cumulative Effective Mortgage
Living in the house Interests paid Principle Repaid Interest Rate
1 17899.77 3684.03 485.87%
3 53003.67 11747.79 150.39%
5 87082.17 20836.92 83.58%
7 120,004.89 31,081.83 55.16%
9 151,624.86 42,629.49 39.52%
11 181,776.45 55,645.56 29.70%
13 210,272.94 70,316.73 23.00%
15 236,903.82 86,853.48 18.18%
9. Based on Question 7 and 8, what intuitions can you draw? What surprises do you see (if
any)? Banks only tell you the nominal interest rate of 6%. Why don’t banks tell you about
the Effective Mortgage Interest Rates? Hint: Think about the effective mortgage interest
rate if a homeowner only stays at a house for a short period of time. (10 points)
We take the intuition that a nominal interest rate of 6% does not represent the cost of the
loan in a true sense, particularly if the homeowner is going to sell or refinance before the
loan term ends. This is because the early payments on the mortgage are predominantly
interest and not principal, which means the effective interest rate can be much greater
than the nominal interest rate especially when the homeowner stays less than the full
mortgage loan term. We take note that banks would not advertise it this way because it is
complicated and less appealing; it is better to report it based on how long the home owner
keeps the loan and the fees. The interesting insight is that most home owners undervalue
their real cost if they do not stay long enough to pay the loan in full.
10. Before understanding the Effective Mortgage Interest Rate, what is your preference
between 15-year and 30-year mortgages? And why? After completing this project, how
does understanding the effective mortgage interest rate change your preference of the
mortgage choice (if any)? (10 points)
Prior to learning about the Effective Mortgage Interest Rate, a 30-year mortgage was
preferable to me because the monthly payments are smaller and more manageable.
However, after completing this project, I realize for a short-term homeowner, the
effective interest rate on a 30-year mortgage can be much larger than you would have
thought. Therefore, if I know I would be in the house long enough, a 15-year mortgage is
more desirable as I pay principal faster and effectively lower the interest I pay.