People who want to buy a home in America usually choose a 30-year fixed rate mortgage. It is estimated that just 3 years ago that 2/3 of all mortgage applications were 30-year mortgages, and 86% of purchase applications were 30 year notes.
But as interest rates are continuing to rise in 2018 into 4.6% or so for a 30-year mortgage, more people are wondering if they should get a 15 year mortgage. While the monthly payment is 40% or so higher per month, you also will pay a lower interest rate, and tens of thousands less in interest over time.
Which should you choose? Is the 30-Year Mortgage Loan the best choice for you?
Mortgage Term Affects Loan Cost
A mortgage is a term loan that is secured by real estate. The borrower will pay interest that is determined each year depending upon the balance of the loan. The rate and payment are fixed in a fixed rate loan.
As the monthly payment does not change, the part that goes to interest and the part that goes to pay down principal will change over the years. When the loan balance is higher, most of the payment is mortgage interest. But as your balance gets smaller, the interest part of the payment will drop. The part that goes towards paying off principal will increase.
In a 30-year loan, the loan balance will shrink much slower. You are essentially renting the same amount of cash for double the time of a 15-year loan. The higher your rate, the more of the gap between the 30 and 15-year loan. If the interest rate on your loan is 4%, a borrower will pay more than two times as much interest with a 30-year loan compared to a 15-year loan.
Difference in Mortgage Rates
Another major factor in the length of the loan is interest rate. Fifteen-year mortgages are less of a risk for the bank and it costs less to make a shorter-term loan, so the rate will be lower. Consumers typically pay up to 1 percent less for a 15-year mortgage, and this difference can add up to a lot of money over time.
Also, government backed agencies, such as Fannie Mae and Freddie Mac, impose various fees that make the 30-year loan more expensive. These fees will apply to people who have lower credit scores and lower down payments. FHA also will charge higher mortgage insurance premiums to people with 30-year loans.
Some of the loan level price adjustments that are on a 30-year loan are not in play with a 15-year loan. Most people roll the higher costs of the mortgage into the loan and do not pay them out of pocket.
So, consider a $300,000 loan that can be had at 4% for 30 years or 3.25% for 15 years. The faster amortization and lower rate mean that if you borrow the money for 15 years, it would cost you only $79,000 and would cost you $215,000 for 30 years.
Of course, there is a big catch here. The price to save all that interest is to pay much more each month. The payment on this 15-year loan would be $2108 compared to $1432 for the 30-year loan.
Defending the 30 Year Mortgage
The reason 30-year loans are popular is that the payment is relatively low, even with interest rates nearing 5% in 2018. The lower payment may allow you to buy more home than with a 15-year mortgage. The lower payment each month also will allow you to have more savings, which you can dedicate to other things.
Some people opt to get the 30-year mortgage and put the money that they save into investments. It is possible for the disciplined investor to get a 30-year loan and take the difference in payment and invest it into things that make you more money.
Other Interest Rate Alternatives
If you do not want to be locked into a 15-year mortgage with higher payments, you also can make larger payments similar to a 15-year mortgage on your 30-year loan. You will still be paying a higher interest rate with the 30-year loan, but you can save a lot in interest over the years by making the 15-year payment. If things get tight, you can always go back to making the 30-year loan payment.
Many experts say that if you can swing it, get a 15-year mortgage because people who have their house paid off early virtually never regret it.