MORTGAGES COME WITH many options, and one of them is your loan term: a 15-year versus 30-year mortgage. A 30-year mortgage can make your payments more affordable, but a 15-year mortgage is generally cheaper overall. As you're weighing your mortgage options, here are the most important things to know about 15- and 30-year mortgages.
How a 15- vs. 30-Year Mortgage Works
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 when applicable, usually when you buy a home with less than 20% down.
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.
What's Good About a 15-Year Mortgage
There are several good reasons to choose a 15-year over a 30-year mortgage.
Pay the home off more quickly.
"The monthly payments will be larger, allowing more money to go to the principal in a shorter amount of time," says Benjamin Ross, a real estate agent in Texas. Your loan balance disappears faster, which might be important to you if you envision a retirement that doesn't include mortgage debt.
Lower interest rate.
Because you're paying your home loan off sooner with a 15-year term, your mortgage becomes less risky for the bank. 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 total over the loan term.
A lower interest rate also benefits you in another way when adding up the total interest paid on the loan. Here's a simple side-by-side comparison of the total interest paid on a $300,000 mortgage.
(Note: These calculations don't include PMI, homeowners insurance or property taxes escrowed into the mortgage.)
|15-YEAR MORTGAGE TERM||30-YEAR MORTGAGE TERM|
|Interest rate: 3%||Interest rate: 3.625%|
|Monthly payment: $2,072||Monthly payment: $1,368|
|Total interest paid: $72,914||Total interest paid: $192,535|
In this example, choosing a shorter loan term and qualifying for a lower interest rate results in a total interest savings of $119,621. That's a substantial amount of money you could keep in your pocket over time.
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 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.
15-Year Mortgage Drawbacks
What's great about 15-year mortgages versus 30-year mortgages is also what makes them less attractive for certain homebuyers: a larger monthly payment.
Going back to the previous example of a 15- vs. 30-year loan, the mortgage payment for the 15-year option is $704 higher. A $2,000-plus monthly mortgage payment may not be realistic for every budget.
"A lot of people are more concerned with ensuring that their monthly payment is manageable than the total interest paid over the life of the loan," says Anthony Sherman, co-founder and CEO of Simplist, a digital mortgage marketplace. "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."
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 your decision-making about which kind of mortgage to get.
What's Good About 30-Year Mortgages
A 30-year home loan also has its advantages. Here's why you might prefer a longer loan instead:
Lower monthly payments.
You don't need to be a math genius to understand that a longer loan term can make your payments lower. 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.
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.
30-Year Mortgage Drawbacks
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 may involve an upfront expense since you have to pay closing costs. You could roll those into your loan, but that can nudge your monthly payments higher.
Another drawback is that you'll take longer to build equity with a 30-year loan, since you're paying a smaller amount toward the interest and principal each month. That could be a disadvantage if you were hoping to take out a home equity loan or line of credit at some point to consolidate debt or finance home improvement projects.
How to Choose a Mortgage Term
The best way to evaluate whether a 15- or 30-year mortgage is better is to consider your plans and priorities.
Specifically, think about:
- How long you plan to stay in the home
- Whether you'd like to tap into your equity eventually
- 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
Timing is particularly important because of how mortgage payments are structured.
"In the first 10 years of the loan, over two-thirds of your monthly payment is comprised of interest," Sherman says. "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, the 15-year plan is a good one," Ross says. "If one is buying a home long term and has no intent on using equity, perhaps a 30-year loan would be more appropriate, especially if they can't afford the higher monthly payment."
When in doubt, run the numbers through a mortgage calculator using 15- and 30-year terms. This can put the short- and long-term financial implications of either loan in perspective.