Choices that need to be made at the time of purchasing a home can be very confusing. Types of loans, the right lender, rate of interest etc. More options come as initial things get decided. This article will help you decide in one such choice. Let’s say you have decided on a fixed rate mortgage which is the simplest and most chosen home loan option. These spare you from the shocks that might come with an adjustable rate mortgage. You however, still have to decide between a 30 year and a 15 year mortgage and see where you can best manage your costs.
Is a 15 year mortgage better than a 30 year mortgage?
Essentially, a 15 year mortgage reduces your total borrowing costs and allows you to get rid of the debt quickly. Whereas, lower monthly payments come with a 30 year loan that allow you to pay unexpected expenses and save for other goals.
Still Confused between the two? Pros and cons of each will be covered in detail below, after which we will discuss about a middle path that can be taken to reap the benefit of both.
Looking at the options, initially, the most apparent difference here in the 15 year and 30 year mortgages is the size of monthly payments. 30-year loans incur a lower monthly payment, however, that does not make them obviously better. There are other less noticeable differences that are worth a closer look.
- Affordable Payments: Based on the size of down payment and your income, a 15-year mortgage may personally be more appealing to you. If there are concerns about the monthly flow of income, stretching out the loan payments to a 30 years may be more comforting. Lenders however, approve loan applications, partially based on your ability to pay it back. To determine the same, they compare monthly income to your monthly debt payments. There may be instances that you would feel comfortable opting for the 15-year mortgage but your case gets disqualified for it due to the unacceptable debt-to-income ratio.
- Other Plans: A 30-year mortgage makes it easier to provide for other life goals of the buyer like travelling or perhaps retirement. Rather than making heavy mortgage payments, you’ll have more money in your budget to put aside for other things that matter for you in life. You might be better off with a 15-year loan if other than the monthly mortgage payments you only spend money on your wants and not saving.
- Flexibility: It is easier to have more options open and deal with life’s surprises with a 30-year loan. For instance, in case you decide to upgrade your ride and buy a new car, lower monthly payment will come in handy.
How Fast You Repay
With a 15-year mortgage you are able to pay and finish off your loan quickly. Every monthly payment pays off a bigger portion of your debt than it would have when compared to a 30-year loan. You will owe less money at any given point, which has its own benefits that are:
- You build equity more quickly, which can be used for the next home purchase or other needs.
- Lower loan-to-value ratio makes it easier to refinance.
- While selling your home for any reason, you’d less likely be underwater.
Plus, in-case you stay in the house, your mortgage payment finishes in 15 years instead of lingering on for 30 long years.
As already mentioned a couple of times above, you pay less interest with a 15-year mortgage than you would on a 30-year mortgage. Two things here work in your favour.
- Rate of Interest: All other things being equal, interest rates are typically lower in 15-year loans than 30-year loans. So, interest paid is less, starting the very first year.
- Lifetime Interest Costs: Longer the duration you borrow for, more interest you pay. Also, due to smaller monthly payment on a 30-year loan, loan balance remains higher for a longer period.
Let’s look at a15-Year vs. 30-Year Comparison with an example to see how all of the factors above work together
We assume –
- You borrow $200,000 to buy a home, and you can choose between a 15-year and 30-year mortgage.
- 30-year fixed-rate loan is offered with a rate of 4.10 percent.
- 15-year fixed-rate loan is offered with a rate of 3.43 percent.
- Monthly Payment
30-year payment – $966
15-year payment – $1,432
Outcome: The 30-year loan has a lower monthly payment.
- Debt Reduction
30-year loan – balance after seven years: $172,513
15-year loan – balance after seven years: $119,674
Outcome: You’ll pay down the balance faster with a 15-year loan.
- Interest Costs
30-year loan – total interest cost on loan: $147,903
15-year loan – total interest cost on loan: $56,122
Outcome: You’ll pay less interest with a 15-year loan
Having cleared all the differences between the two options, it should now be easier to decide whether a 30-year mortgage will be better for you or a 15-year mortgage. But we do have a middle way you can take and get the best of both. If the higher monthly payment on the 15-year loan is too daunting, you can instead, opt for a 30-year loan and pay extra every month. Just calculate your payments as if you have a 15-year mortgage, and till the time an emergency or unfavourable situations come up, keep paying that higher payment. This strategy helps get rid of the debt sooner and you end up paying lesser interest than you would have by paying as a normal 30-year mortgage. However, to get the benefit of absolute minimum rate of interest, go ahead and commit to a 15-year mortgage so that you are offered the lowest interest rate possible.