The home buying process is full of decisions, even before you start looking at houses. Who should your agent be? Who should your lender be? What type of loan should you get?
Though figuring out the answers to so many questions can at times be extremely stressful, it is also imperative that you make the right choices.
If your lender asks whether you are applying for a 15-year mortgage or a 30-year mortgage, don’t just choose the 30-year because it’s the most common.
If you can afford a 15-year mortgage you could save yourself thousands of dollars over the life of your loan.
Even though the monthly payments on a 30-year mortgage are lower, with the interest rate being paid 15 years longer than a 15-year mortgage, a 30-year mortgage will end up costing you significantly more money over time. Understanding concepts like these are how the wealthy stay wealthy.
How much can you save with a 15-year mortgage vs 30-years?
For example, let’s take a loan amount of $300,000, at a fixed rate of 4.5 percent interest, payable at 12 monthly payments of $1,520 over 30 years. Over the life of the loan, you’ll end up paying $247,220 in cumulative interest. With the same loan amount and terms, except payable over a 15-year loan and a $2,295 monthly payment, your cumulative interest is only $113,096.
Talk about savings — that’s a difference of $134,123, a pretty nice chunk that could go into your retirement account, your kids’ college funds, or even to finance improvements on your house.
Another point is that interest rates are typically lower on a 15-year mortgage. So with a 15-year loan, not only do you get a lower interest rate, but you also have 15 fewer years of paying interest, compared to a 30-year mortgage. The ultimate goal of creating equity and then owning the house free and clear is of course obtained must faster through a 15-year mortgage than through a 30-year.
The downside is that your payments are going to be significantly higher with the 15-year loan. For some buyers, the only way to afford the payments on a 15-year mortgage is to get a much smaller house than they were originally imagining. It’s all a matter of keeping well within the confines of your household’s budget.
Let’s break down the benefits of 15-year mortgages and 30-year mortgages:
Why go with a 15-year mortgage
- Build equity and pay off your home faster
- Lower interest rate
- Pay less interest over the life of the loan
Why go with a 30-year mortgage
- Lower payment provides more wiggle room financially
- Afford your “forever home” sooner
Extra mortgage payments as an alternative to a 15-year loan
Maybe you already have a 30-year mortgage but don’t want to (or can’t) refinance. Here’s a bit of a middle ground. Make extra payments on your 30-year mortgage whenever possible. Put your annual bonus toward your mortgage. Plan to make at least one extra payment per year.
The amount of money you’ll save depends on the specifics of your loan. Take the following example from Kiplinger.com:
Making one extra payment on a 15-year, $300,000 mortgage with a 5 percent interest rate breaks down to about $200 extra per month. If you pay $2,572 each month instead of the required $2,372, for example, you can cut the number of payments down from 180 to 161 (from 15 years to 13.4) and the total interest paid from $127,029 to $111,653. The higher the interest rate, the more you’ll save by making extra payments.
Risks with 15-year mortgages
Generally speaking, the idea of paying off your mortgage in half the time is a wise one. But of course, if you choose to buy the same house and go for much higher payments, you could be putting your finances at risk.
Sure, everyone wants to save money on interest and pay off their home faster, but what if an emergency comes up? Would you still have enough money for your emergency fund? Would you still be able to contribute to your retirement account or your kid’s college fund if you end up going with a 15-year mortgage?
If you can do both, great! But not everyone can.
There is no one right answer, but these are factors to consider. Certainly, I would have loved to be able to get a 15-year mortgage. But I decided to get a 30-year mortgage so that I could simultaneously contribute to my emergency fund, my self-directed 401k and my son’s college fund.
What about you? Do you have a 15-year or 30-year mortgage? Why did you choose it?