The current mortgage rates are still very low, with a 30 year fixed mortgage hovering in the 4% range and 15 year fixed mortgages at 3.625% (3.855% APR). With rates this low, many people are thinking about either buying a new home or refinancing.
Does it make sense to do a 15 year mortgage instead of a 30 year mortgage?
A 15 year mortgage can save you hundreds of thousands in interest over the life of the loan. Meanwhile, the 30 year home loan has lower payments, but you will pay much more in interest over the long term. Let’s take a close look at both options and you can decide which the best is for you.
15 Year Mortgage Saves You Money
Using a 15 year mortgage to finance your home will give you a higher monthly mortgage payment. The advantage is that you will save a huge amount of interest by paying interest for only 15 years, rather than 30. A 15 year mortgage is often the best choice for people who want to save money in the long term, for two reasons:
- As we showed above, the current rate for a 15 year mortgage is lower than a 30 year mortgage. Right now, that difference is approximately ½ of a point. The 15 year loan holder will pay less interest each month, so the bank or lender makes less.
- After 15 years, there is no more mortgage to pay. This is half the time that you pay on a 30 year mortgage. You will have no mortgage payment 15 years sooner, which will make your life easier, at least for most of us.
These two factors combined means that the typical 15 year borrower will save several hundred thousand dollars over the life of the loan.
Look at it this way:
- With 15 year mortgage rates, your first payment is roughly 66% principal and 34% interest.
- With a 30-year mortgage, your first payment is roughly 35% principal and 65% interest.
A 30 year loan does not include the same principal to interest ratio until year 18. So, a 15 year mortgage can be a great fit for someone who can afford the higher payments, and wants to do other things with that mortgage money after 15 years.
Many people decide to get a 15 year mortgage and once it is paid off, they can use that money to travel or to possibly invest in real estate or other finance investments.
In most cases lenders who offer conforming and non-prime financing will offer both the 30 and 15 year term options. Check conventional and subprime mortgage rates now.
15 Year Mortgage Refinance Is Popular
Because 15 year mortgage rates are under 4%, quite a few homeowners have been choosing the shorter loan term. In fact, mortgage companies report that approximately 30% of homeowners are switching into a 15 year mortgage from a 30 year mortgage for the year 2015. This is many times more than the beginning of the decade.
Because rates are so low for the 15 year mortgage, some people are able to switch to a 15 year mortgage and see only a small change in their payment.
15 Year Loan Considerations
As with any financial product, the 15 year refinance mortgage does not suit every situation. It does provide people with enormous, long term interest savings, but it is not for every borrower.
For most people, the monthly payment on a 15 year mortgage will be up to 50% higher than a 30 year mortgage. That type of increase can be beyond the budget of many people. Many homeowners are in their 20s and 30s, and may have children. They may simply not be able to afford that much of an additional payment and still care for their families.
Also, it is harder to qualify for a 15 year mortgage, given the debt to income requirements. The lender will look carefully at your financial documents and weigh if you will be able to afford that type of payment every month.
Before you decide that you want to do a 15 year mortgage, you really should look at your financial situation. Decide if you will be able to dedicate the extra money each month to your mortgage without coming short on funds for other needs.
If you still want to have the benefits of a 15 year loan most of the time, there is another option.
There is nothing illegal about refinancing into a lower rate, 30 year mortgage, and then send an additional 50% to the lender every month.
You will benefit from a lower interest rate and you will reduce your loan term by 15 years. If you ever think you cannot make the extra monthly payment, you are under no obligation to do so.
There is no perfect mortgage for all borrowers. But many financial advisers will counsel borrowers to get a 15 year mortgage if they are able to handle the additional financial strain. The savings over the life of the long are so large, it really does make sense for many people to go for the 15 year loan.
Even if you have been denied a loan because of low fico scores, there are several bad credit mortgage programs available with terms ranging from ten to thirty years.
How to Know When the 15 Year Mortgage Is a Good Fit
For decades, the standard mortgage product in the United States has been the 30-year, fixed rate mortgage. The 30-year mortgage is the choice for 85% of homeowners. However, the 15-year mortgage is getting more popular as mortgage interest rates in late 2017 are still hovering near 4%.
Should you get a 15-year mortgage instead of a 30-year mortgage? For some homeowners, it may be the right choice. Here is how to discover if the 15-year mortgage is a good fit for you.
30-Year Mortgage Reduces Payments
The reason that most people get a 30-year mortgage is that you can buy a home in many cases for a reasonable monthly expense. Most people will pay substantially less per month with a 30-year mortgage than they will if they rent the same home.
For instance, if you were to get a 15-year mortgage on a $200,000 home, you would pay roughly $1400 per month for the principal and interest payment. The payment for the 30-year loan would be only $950 or so.
People who are able to pay more on their mortgage each month may choose to make the higher 15-year loan payment. This will greatly reduce the interest you pay and will pay off your home much faster.
But people who like to pay the 30-year loan amount will be able to buy more home. Lenders qualify borrowers based upon debt as a percentage of your monthly income. One of the common rules is that your monthly mortgage payment should be no more than 28% of your gross monthly income.
If you make $5000 each month, it means that you can likely afford the $1,400 mortgage payment. This monthly amount will mean you will be able to buy a bigger and nicer house with a 30-year mortgage over a 15-year mortgage.
15-Year Mortgage Saves You Big Over Time
Clearly, the biggest advantage of the 15-year mortgage is that you will pay off your home much faster. You also will build equity much faster and have less debt faster than with a 30-year mortgage.
There are other benefits of a 15-year mortgage. Even though you are paying more each month, you are enjoying several money-saving benefits. First, a 15-year mortgage is a lower risk to the lender. So, your interest rate on a 15-year mortgage will be lower.
For instance, a borrower with a 720-credit score can get a loan on a 30-year mortgage with an interest rate of approximately 3.8%. But if you get a 15-year mortgage, you could enjoy a rate of approximately 3.3%.
Further, the math on mortgage amortization also definitely works well for you with a 15-year mortgage. The main thing to remember is that more of your payments on a 15-year mortgage will pay off the principal faster than on a 30-year mortgage.
The savings over time with a 15-year mortgage can be huge. This is because you are paying on a 30-year mortgage for twice as long as a 15-year mortgage. You might think that you would pay roughly double the interest over the term of the loan, right?
Actually, a 30-year loan is even more expensive than that. On a $200,000 mortgage with a 30-year note, you would pay about $345,000 in interest on the above example. On a 15-year loan, you would pay only $55,000 in interest. That is about 60% less than a 30-year loan.
Which Term Is the Best Choice for You?
This really depends upon you and your financial circumstances. Below are some of the ways to know that a 15-year loan might be best for you:
- You can afford a higher monthly payment. If you have the income that you can qualify for the higher payment of a 15-year mortgage, you may want to do it. Your lender will need to be able to see that you have the income to afford a payment that is roughly 30% more than the payment on a 30-year loan.
- You think your income will go up over time. People who get a 15-year loan are often betting on their income rising over time. If you think that your profession and job skills will lead to a higher income over the years, you may want to get a 15-year mortgage.
- You want to be sure you have the house paid off before retirement. Many people want to have their home paid off before they retire and have a lower income. If you are confident of when you will retire, it can make sense to have the home paid off ahead of time with a 15-year mortgage.
- You want to save on interest payments. If you can afford the higher monthly payment, you will be able to save massively on interest over time. People who have a sufficient income to handle the higher monthly payment may want to enjoy the much lower interest payments over time.
15-year mortgage is harder to pay each month, but there is no question that paying your home off in 15 years instead of 30 has many tempting financial advantages. If you can afford the higher payment, having your home paid off 15 years early can give you a high level of financial freedom.
References: 30 Year vs. 15 Year Mortgage – Which Should I Pick? (2017, Feb. 2). Retrieved from https://www.fool.com/mortgages/2017/02/11/30-year-vs-15-year-mortgage-which-should-i-pick.aspx