Inside: Learn whether a 15 or 30-year mortgage is right for you.
Have you sat down to look at mortgages and one of you says the 15-year loan makes the most sense and will cost less, but the other really likes the lower payments on the 30-year loan?
Who is right? Let’s find out.
Advantages of a 30-year mortgage
If you are shopping for a home, it should come as no surprise that when mortgage rates are quoted, the default is to quote rates for a 30-year fixed mortgage. This is because, of all the different types of mortgages available, almost 85% of homebuyers in the U.S. use this type of loan.
And why is a 30-year mortgage popular?
The primary reason is that the monthly payments are smaller than you would find with a shorter-term loan. This simple fact helps in two ways.
The first is that when you are trying to get pre-approved for a loan, lenders look at your DTI (debt-to-income) ratio. To qualify for a loan, you will want all your monthly debt payments to be no more than 36% of your income, even after buying a home. So, a lower monthly mortgage payment helps those numbers.
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The second way smaller monthly payments helps is that, as long as you aren’t overextending yourself, it creates wiggle room in your budget. We’ll come back to this in a moment.
Disadvantages of a 30-year mortgage
The primary disadvantage of a longer-term mortgage is you will likely end up paying more overall for the home. How much more? There are many calculators available that can help you determine interest paid and more.
Here is a scenario using today’s rates:
Let’s say you get a $200,000 mortgage and you have a credit score of 750. (The credit score determines your interest rates)
A 30-year loan at 4.34% will have monthly payments of $994 per month, a total of $158,001 in interest charges, leading to a grand total of $358,001.
Now, a 15-year loan at 3.96% will have monthly payments of $1475, a total of $65,567 in interest charges, giving you a total of $265,567 paid on the home.
So, is spending a total of $92,434 more worth having a monthly payment that is $481 less?
Advantages of a 15-year mortgage
As you can see, the biggest advantage of having a 15-year mortgage is that it can save you a lot of money in the long run. Why? That happens because you aren’t paying all that higher rate interest over such a long period.
Did you notice that interest rates for 15-year loans are lower than those of the 30-year mortgages? The shortened timespan translates to the lenders as a reduced risk so they offer lower rates for the shorter term loans.
Another huge advantage a 15-year mortgage has is that because the term is shorter, you are done paying in half the time. This is great if you worry about having mortgage payments beyond retirement.
Disadvantages of a 15-year mortgage
Yes, you can save a lot of money by getting a 15-year mortgage. But, did you notice the monthly payments? They are nearly 50% higher than the monthly payments on the 30-year loan.
The higher monthly payment also skews the numbers for your debt-to-income ratio, which means you will likely qualify for a smaller loan amount, meaning a smaller home.
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15-year vs 30-year mortgage: Which is better?
The 15-year mortgage has a lot going for it. Because you are paying more towards principal, you build equity in the home faster. The shorter period means you are done with payments sooner, and you pay less in interest.
But are you ok with a smaller home? Smaller and simpler does seem to be the trend lately. And if you can still save for retirement and other goals while making the mortgage payments, this type of mortgage is a great option.
The 30-year mortgage may seem like a loser’s bet on paper. BUT.
There is that lower monthly payment.
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That lower payment may give you enough wiggle room in your budget to afford the mortgage even if one of you lost his job for a while. Or you could have enough to pay daycare in a few years if you are thinking about children.
Some people even choose to invest monthly the difference between the 30-year payment and the 15-year payment. Over the long term, a good index fund will likely give you a better return than the interest paid down on the mortgage.
Most people will spend the extra money on stuff. If you go with the 30-year mortgage, what will you do with that wiggle room? Save? Invest? Spend?
Now you need to decide what works for you. There really is no right answer for everyone.
Full disclosure: On our first house, we were young and starting our careers, so we opted for a 30-year mortgage because of the lower payments. We also started investing aggressively and made extra principal payments as well to get rid of PMI. After six years, we sold that house and got another house with a 15-year mortgage.
As you can see, the right answer for us varied with our situation at the time. Young DINKs (dual income no kids) vs older with two kids plus lower interest rates made for very different situations. While the math definitely favors one solution, life and emotions may direct you toward another.
What type of mortgage do you have and why did you choose it?