Mortgages are unique like you and I and there is not a "one size fits all."
One of the choices is the loan term: A 30-year mortgage can make your payments more affordable, but a 15-year mortgage may have a lower interest rate. As you're considering your home loan options, here are the most important things to know.
A mortgage is a type of term loan, meaning the amount you borrow is repaid over a set period of time. You make principal and interest payments according to an amortization schedule that's set by the lender. Your monthly payment schedule may also include homeowners insurance and property taxes if those are escrowed into your payment. Private mortgage insurance is also added whenever you buy a home with less than 20% down.
How to Choose a Mortgage Term:
- How long you plan to stay in the home
- The amount you plan to borrow and how much you'll put down
- What size mortgage payment you can reasonably afford
- How a mortgage payment affects your ability to pursue other financial goals
There are several reasons to choose a 15-year over a 30-year mortgage.When you have a 15-year mortgage, the total amount you have to repay is spread out over 15 years, or 180 payments. If you choose a 30-year mortgage instead, you repay the loan over 30 years, or 360 payments.
Pay the home off more quickly with a 15yr mortgage.
The monthly payments will be larger than a 30yr mortgage, allowing more money to go to the principal in a shorter amount of time. Your loan balance decreases faster, which depending upon when you purchased might be important to you if you envision a retirement that doesn't include mortgage debt.
Lower interest rate.
Some lenders see a 15-year term as less risky. That may translate to a lower interest rate compared with a 30-year loan. Depending on the overall interest rate environment, rates for a 15-year mortgage may be a half a percentage point or more lower than 30-year mortgage rates.
Less interest paid over the loan term.
A lower interest rate also benefits you in another way when adding up the total interest paid on the life od the loan.
Build equity faster.
Home equity represents the difference between what your home is worth and what you owe on the mortgage. When your monthly payment is larger with a 15yr because your loan term is shorter, you can build equity at a quicker pace because you're paying more of the loan principal down each month compared with what you would with a longer mortgage.
What's great about 15-year mortgages versus 30-year mortgages is also what makes them less attractive for certain homebuyers: the larger monthly payment.
In getting your mortgage you need to be concerned with ensuring that the monthly payment is manageable than the total interest paid over the life of the loan. Paying off your mortgage over a longer period of time can free up cash to do other important things, like investing, saving for college or retirement, and paying for renovations. And if you have extra money to pay towards principle you can pay down a 30yr mortgage in about 17 years.
Another reason to reconsider a shorter loan term is how long you plan to stay in the home. If you plan to move within the next five years, for example, then being able to build equity faster or get a lower interest rate on the loan may not be as important in deciding which kind of mortgage to get.
A 30-year home loan has its advantages.
Lower monthly payments.
You don't need to be a math genius to understand that a longer loan term can reduce your monthly payment. That might be attractive if you want to be able to work on other financial goals while you pay down your home loan. If you're getting a larger mortgage, being able to pay over 30 years could make the payments more affordable for your budget.
Payment flexibility.
While you're agreeing to a 30-year mortgage term, you can still choose to make extra payments. That could help you pay the loan off ahead of schedule.
More potential for tax savings.
Interest on home loans is tax-deductible. When you have a 15-year loan, you're paying off more of the interest upfront, so you may not benefit from the tax deduction as long as you would with a 30-year mortgage instead.
There are some drawbacks to choosing a 30-year home loan over a shorter term.
As the earlier example showed, the biggest drawback is interest. Not only can you end up with a higher interest rate on a 30-year mortgage, but you'll also pay more total interest on the loan. That assumes, of course, that you stick with the same loan term and don't refinance to a shorter mortgage at any point.
Refinancing from a 30-year loan to a 15-year loan could save you money if you're able to get a lower interest rate. Whether refinancing makes sense depends largely on the difference between your current interest rate and the rate you'd qualify for, as well as how much you still owe on the mortgage. Keep in mind that refinancing involves costs and possible upfront expenses since you have to pay closing costs. You could roll those into your loan, but that could make your monthly payments higher.
The best way to evaluate whether a 15- or 30-year mortgage is better is to consider your short and long term goals.
Specifically, think about:
Timing is particularly important because of how mortgage payments are structured.
In the first 10 years of the mortgage, over two-thirds of your monthly payment is comprised of interest, so if you don't plan on living in your home for more than 10 years, you'll end up paying a lot of interest but only paying down very little of the original principal.
Thinking big picture, in terms of your larger financial goals, can help you decide which loan option is a better fit for your situation.
If the goal is to build quick equity and pay off the loan sooner, then a 15-year plan is a good one. If you are buying a home long term and has no intent on using equity, perhaps a 30-year loan would be more appropriate, especially if you can't afford the higher monthly payment.
When in doubt, meet with your local mortgage expert and talk about your goals. Then have your mortgage expert run the numbers for both the 15- and 30-year terms. This can put the short- and long-term financial implications in perspective so you can make an informed decision.
