Borrow on a 30-Year Mortgage and Invest the Difference?

On the popular social media site, Tik Tok, a recently circulated video has gained a lot of notice.  Its premise is that a smart financial move is to take out a 30-year mortgage on your home instead of a 15-year mortgage and invest the difference.  The video distinguishes between a 15- year mortgage and a 30-year stating the 30-year is a better strategy even though the 15-year interest rate is lower.  So, does this strategy make good financial sense?  The answer is, “Yes and no.”

Why this might be a good strategy

What makes this strategy intriguing is that we have historically low interest rates.  Currently, you can get a 15-year fixed mortgage rate at about 2.5% or a 30-year mortgage at about 3.0%.  Assuming a $200,000 mortgage, the payments on a 15-year would be $1,334 per month with total interest payments of $40,044.  A 30-year would have payments of $844 per month with total interest payments of $103,500.  The difference, $490 per month, is what you’d have to invest.  Historically, stocks earn 9% to 10% over the long term, so if your $490 per month investment earned a constant 9% for thirty years, you’d have $900,000.

Why this might not be a good strategy for you

First, for this strategy to work, you must invest the difference month-in and month-out.  Also, the $900,000 does not take into account taxes on capital gains, dividends and interest.  It also requires that you invest primarily or solely in stocks since current interest rates on savings are well below mortgage interest rates.  With stocks, you will not get a 9% constant rate of return, so your end result will likely vary widely.  Finally, stocks are very volatile in the short term, and many people lack the mental fortitude to stay the course when the stock market appears to be imploding.

Having said all of this, I do like the flexibility of the 30-year mortgage, especially when the interest rate difference between the 30-year and 15-year is so small.  It allows you to choose to make additional payments when you can afford to do so but also back off to the 30-year schedule should your cash flow become tight.  And yes, you could invest the difference.  If possible, use a Roth IRA or Traditional IRA, or, even better, use the added cash flow to invest in a matching 401k plan if you are not already doing so. Before making any decisions, review with your professional advisor and make sure it’s the right decision for your circumstances.

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