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Tax planning: 30 year vs. 15 year fixed mortgage who wins?

TaxBizPro, LLC Posted on: December 17, 2011 19:29

If you are ready to purchase your dream home, a careful tax analysis about different types of mortgages must be done. If you want to know about big tax write-off a mortgage can give you, you should learn how mortgages work and then sit down with a tax advisor or an accountant and determined whether a 30-year mortgage is better or worse for you than the 15-year mortgage. This task might be confusing and you need to make sure you have a clear picture and help from your tax accountant. You can use mortgage calculator to compute the monthly payments on a 30 years or 15 years mortgages. This tool will help you budget your personal expenses and you will see how much the monthly payment will be on your new mortgage.

What if you take out a 30-year fixed rate mortgage?

If you decided to take out a 30-year fixed rate mortgage, you will be able to borrow money for a longer term. Your interest rate will be fixed and not fluctuate according to the changing mortgage markets. The payments for a 30-year mortgage will be lower then for the 15-year mortgage because of extra 15 years in payments. Thus, the monthly payments on a 30-year mortgage will be more affordable to you. When you make a mortgage payment, one portion will be the principal (this is what pays down your mortgage that you owe to the bank) and the other portion of the payment is interest that you pay on the outstanding loan balance. Every time you make the mortgage payment, the principal portion increases and interest portion decreases. See the chart below (aka amortization schedule). This chart only illustrates 20 months on a regular 30-year fixed mortgage for $325,000 at 5% interest rate:
Month
Date
Payment
Interest
Principal
Loan Balance
Loan
01/01/12
 –
 –
 –
 $              325,000.00
1
02/01/12
1,744.67
1,354.17
390.50
324,609.50
2
03/01/12
1,744.67
1,352.54
392.13
324,217.37
3
04/01/12
1,744.67
1,350.91
393.76
323,823.60
4
05/01/12
1,744.67
1,349.27
395.40
323,428.20
5
06/01/12
1,744.67
1,347.62
397.05
323,031.14
6
07/01/12
1,744.67
1,345.96
398.71
322,632.44
7
08/01/12
1,744.67
1,344.30
400.37
322,232.07
8
09/01/12
1,744.67
1,342.63
402.04
321,830.03
9
10/01/12
1,744.67
1,340.96
403.71
321,426.32
10
11/01/12
1,744.67
1,339.28
405.39
321,020.93
11
12/01/12
1,744.67
1,337.59
407.08
320,613.84
12
01/01/13
1,744.67
1,335.89
408.78
320,205.07
13
02/01/13
1,744.67
1,334.19
410.48
319,794.58
14
03/01/13
1,744.67
1,332.48
412.19
319,382.39
15
04/01/13
1,744.67
1,330.76
413.91
318,968.48
16
05/01/13
1,744.67
1,329.04
415.63
318,552.85
17
06/01/13
1,744.67
1,327.30
417.37
318,135.48
18
07/01/13
1,744.67
1,325.56
419.11
317,716.37
19
08/01/13
1,744.67
1,323.82
420.85
317,295.52
20
09/01/13
1,744.67
1,322.06
422.61
316,872.92

As was explained above the 30-year mortgage has extra 15 years payments thus more interest will be paid to the bank. That might not be such a bad idea, because that mortgage interest can be tax deductable for many taxpayers that itemize on their personal income tax returns. The tax deduction depends on your tax bracket, so if your tax bracket is 30% (Federal and State combined), you will be able write-off 30% of the interest you paid against the tax liability you would owe. For example, your paid 15K in interest, then, 5K would be a tax write-off and you will be able to reduce your taxes by 5K. In addition, property expenses such as real estate taxes are also deductable to the same extent. So clearly, a 30-year mortgage would be better for those people that want to have lower monthly payments, thus it is easier on the monthly cash flow and in addition, you receive bigger tax deduction on your personal income tax return.

What if you take out a 15-year fixed rate mortgage?

If you decide to take out a 15-year fixed rate mortgage, then as a borrower you will be able to build home equity much faster then with the 30-year mortgage. This happens because the life of the 15-year mortgage is shorter, thus the payments will have less interest and more principal payment allowing you to pay your loan faster. See the chart below and compare it to the 30-year mortgage chart above. Usually, the interest rates will be lower on a 15-year mortgage than that of the 30-year mortgage term. However, your monthly payments will be significantly higher and that might create a big strain on you to make those payments.  Hence, if you fail to manage your budget and miss on payments, you may fall into more borrowing debt and eventually your property runs into a risk of being foreclosed. Because payment are bigger under the 15-year mortgage, you might not be able to afford a bigger house for your growing family.  See the chart below, same terms as for the charge above i.e. 20 months, 15-year fixed mortgage, $325,000 loan at 4% interest rate:

Month
Date
Payment
Interest
Principal
Loan Balance
Loan
01/01/12
 –
 –
 –
 $              325,000.00
1
02/01/12
2,403.99
1,083.33
1,320.66
323,679.34
2
03/01/12
2,403.99
1,078.93
1,325.06
322,354.28
3
04/01/12
2,403.99
1,074.51
1,329.48
321,024.81
4
05/01/12
2,403.99
1,070.08
1,333.91
319,690.90
5
06/01/12
2,403.99
1,065.64
1,338.35
318,352.55
6
07/01/12
2,403.99
1,061.18
1,342.81
317,009.73
7
08/01/12
2,403.99
1,056.70
1,347.29
315,662.44
8
09/01/12
2,403.99
1,052.21
1,351.78
314,310.66
9
10/01/12
2,403.99
1,047.70
1,356.29
312,954.37
10
11/01/12
2,403.99
1,043.18
1,360.81
311,593.56
11
12/01/12
2,403.99
1,038.65
1,365.34
310,228.22
12
01/01/13
2,403.99
1,034.09
1,369.90
308,858.32
13
02/01/13
2,403.99
1,029.53
1,374.46
307,483.86
14
03/01/13
2,403.99
1,024.95
1,379.04
306,104.82
15
04/01/13
2,403.99
1,020.35
1,383.64
304,721.18
16
05/01/13
2,403.99
1,015.74
1,388.25
303,332.92
17
06/01/13
2,403.99
1,011.11
1,392.88
301,940.04
18
07/01/13
2,403.99
1,006.47
1,397.52
300,542.52
19
08/01/13
2,403.99
1,001.81
1,402.18
299,140.34
20
09/01/13
2,403.99
997.13
1,406.86
297,733.48
As you can see the difference in monthly mortgage payment between 30-year and 15-year is $659.32 per month more on the 15-year mortgage. Thus, it is totally depends on you to assess your financial condition and strengths and then decide what type of mortgage will be suitable for you for cash flow and tax savings purposes. Before you take out any loans, try to use a mortgage calculator to determine which loan term will be more suitable for your budget.

Gabriel Knight contributed to this article.

Posted in:Personal Tax ArticlesThis article was written by TaxBizPro, LLC 2017, all rights reserved ©.  

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