Your home is typically your biggest investment and, until it is paid off, probably your biggest monthly expenditure too. Most of us who have houses also carry mortgages. And these mortgages are usually fixed at a certain percentage rate for 30 years.

I recently refinanced on my house, knocking my APR from 6% down to 5.5%. However, even with this lowered rate, my monthly mortgage payment is still going be a little over $900. That is an amazing amount of money. On my salary, it takes me a good third of a month to earn this sum. What’s even worse is me knowing that most of the cash is going towards interest on the loan, not the principal. And also, unless I step up with extra payments, I will be paying this sum until I’m just ready to retire. 

Signing the mortgage agreement, and witnessing the reams and reams of paper projecting payments for the next 30 years, can be quite sobering. While we gain a comfortable place in which to host our BBQs and birthday parties by buying a house, we also limit our freedom. Our comfortable abode can easily become our very comfortable prison. And God-forbid you lose your job, and become unable to pay those monthly payments!  

In light of this, many people take the high road and agree to 15 year mortgages, even paying in additional money so as to shorten the mortgage time further. Other folks look at a mortgage as a way of life, choosing to place their extra funds into stocks and other investments. Which way is better?

Let’s take a look at the shorter mortgage argument camp. By taking a 15 year mortgage, you drastically reduce the amount of interest paid over the life of the loan. For example, $160,000 borrowed at 5.5% APR for 15 years results in a payment of $1307/month. If you took this 15 year mortgage today, August 2009, $574 of the $1307 payment would go towards principal,and the remaining $733 would go towards interest. By February of 2012, greater than 50% of your payment would be applied towards your principal. 

If you took the same loan for 30 years, you would end up paying $908/month. Of that $908, $175 would go towards principal and the remaining $733 would go towards interest. You would have to wait until February of 2027 before greater than 50% of your payment was going towards the principal. That’s a difference of 15 years!

What about the argument from the longer mortgage camp that all that interest is tax deductible? Let’s crunch the numbers: for the same $160,000, a 15 and 30 year loan will each cost $8,623 and $8,746 , respectively, in interest in the first year. Not much difference so far. Let’s now look at year 10 of the same two loans: for the 15 year loan, interest stands at $4,100. For a 30 year loan, the same time period has generated $7,364 in interest. When the 15 year loan holder does his/her taxes, he/she will deduct the mortgage interest, saving about $3,000-$4,000 on taxes. This may even result in no net interest having been paid on the house. However, the 30 year loan holder will not be so lucky. Even if the tax deduction results in no extra money being paid for income taxes, the 30 year loan holder has already lost over $3,000 to interest.

Granted, 15 year loans do cost more on a monthly basis compared with 30 year loans. As stated before, the payment difference for a 15 year versus a 30 year loan on a sum of $160,000 at 5.5% is about $400. What if one simply took that extra cash and invested it in stocks?

Not to dissuade people from investing, but the stock markets have not been very promising lately. Unless one has some sure-fire dividend stocks lined up, that $400/month investment could dwindle away into nothingness. Also remember that, for every $400/month taken away and not invested in the mortgage, the $400 that is being used for investment is racking up 5.5% every year in interest. For the sum of $4,800 ($400/month x 12), that’s an additional $264 in interest every year.

If you can guarantee that your investment income will outpace the interest rate on the mortgage, then investing outside of the mortgage may be of benefit to you. However, you will have to find some high earning stocks, preferably the kind that come with dividends. Alternatively, you might use the cash to purchase a tax lien or two.

On a final note, there may be one final reason to not place all your extra cash into a mortgage. If you have any short-term goals or dreams, such as traveling, buying property, or opening up a new business, then you need to set aside what cash you can for the realization of these goals and dreams. Waiting 15 years until your mortgage is paid off just won’t cut it. Likewise, if you are uncertain about your job, then you cannot sink all the money you have into the mortgage. A house is not a bank, and will not return your cash to you without a stiff price.

However, if you are settled down, with a steady job, the argument of taking a longer mortgage makes no sense. It is best to sign on for a 15 year loan and get it out of the way while you are still (relatively) young and healthy. After all, you never know what the future holds, and it’s anyone’s guess whether you’ll still be working, or be capable of working, 30 years down the road.