Choosing the Right Mortgage Loan: 15 or 30 Years?
When my husband and I decided to refinance our home earlier this year, we were faced with the major decision all home loan borrowers face — 15-year mortgage or 30-year mortgage?
Whether you are buying a home for the first time or whether you're an old pro at the refinancing game, you need to determine whether it makes more sense for you to get a 15-year mortgage or a 30-year mortgage. (See also: The 7-Year Mortgage: Take It or Leave It?)
While you will also need to decide whether you want a fixed rate loan or an adjustable rate loan, the first big decision you make has to do with the length of your mortgage term.
In the end, the decision is usually made based on monthly cash flow.
15-Year Mortgage
The biggest advantage of the 15-year mortgage is that you can save money over the life of your home loan. Not only do you have the loan for a shorter period of time, but you also usually have a lower interest rate.
Consider a $200,000 loan. A 15-year mortgage has a rate of 2.6% fixed, and a 30-year mortgage has rate of 3.4% fixed. This calculation doesn't include PMI, taxes, insurance, and other costs that might come with a mortgage.
With a 15-year mortgage, your total on that loan would be $241,742.46. The total on a 30-year mortgage would be $319,306.49. You can see that you save a great deal by choosing a 15-year mortgage. Plus, you pay off the mortgage much faster. It can be a great choice for someone who is interested in saving money and paying off the house as soon as possible.
The main downside with a 15-year mortgage is that you have a higher mortgage payment.
In our scenario above, the 15-year monthly payment is $1,343.01. That, of course, doesn't include your other costs, from property taxes and insurance to utilities and maintenance. Compare that to the $886.96 monthly payment that comes with a 30-year mortgage.
30-Year Mortgage
30-year mortgages are popular mainly because they are more affordable on a monthly basis. When you get a 30-year mortgage, you can usually shave off between $300 and $500 a month, depending on the interest rate and the size of the mortgage.
For someone just starting out, a 30-year mortgage is desirable because it makes the home more affordable. Many couples buying a first home have a hard time affording the monthly payment associated with a 15-year mortgage.
Payment Flexibility
Another advantage of a 30-year mortgage is that you have a certain degree of flexibility — even if you can afford the payments associated with a 15-year mortgage. When my husband and I refinanced our home, we decided to go with the 30-year mortgage, in spite of the fact that we could afford a 15-year loan. We realized that we have a certain amount of payment flexibility with a 30-year loan. This is comforting, since our income is variable.
We can make 15-year loan payments with our 30-year mortgage. So, even though we have a lower monthly payment, we can pay more each month, applying the extra toward the principal. If you are interested in paying off your loan as quickly as possible, there is nothing preventing you from making payments as though you have a 30-year loan. If you run into financial trouble, you can stop making your extra payment, and return to the payment that you agreed to.
With a 15-year mortgage, you are stuck with that higher payment — no matter what. If you miss payments because of financial difficulty, you run the risk of foreclosure. If all you need is $300 or $400 of breathing room for the month, and you are used to making 15-year payments on your 30-year mortgage, you have that option to cut back without jeopardizing your credit rating or your home.
How to Decide Which Mortgage to Get
Whether you choose a 15-year mortgage or a 30-year mortgage, it's important to make sure that you can handle your payments right now. Even the lower payments associated with a 30-year mortgage can be a problem if the mortgage is just barely affordable for you.
In some cases, it's a straightforward look at the numbers. Can you afford the monthly payment with a 15-year mortgage? If not, you have little choice but to go with the 30-year mortgage. You can refinance to a 15-year mortgage, with a lower rate and a higher payment, after your income situation improves.
However, if you have income flexibility, weigh the pros and cons. Decide what is most important to you. If paying off your mortgage as quickly as possible is the most important consideration to you, a 15-year mortgage will force you into disciplining yourself to make those payments. At the same time, though, a 30-year mortgage can allow you the same ability (just make extra payments) while providing you with a level of flexibility in your payments.
Another consideration is whether or not you really need to pay off your mortgage so quickly. While it sounds nice in theory to pay off your mortgage in 15 years, while building up equity, for many that isn't a particular concern. This is especially true in a low interest rate environment like we are experiencing right now. If you can lock in a low interest rate for 30 years, and then invest the money you are saving each month over the 15-year payment, you can actually come out ahead, depending on market conditions.
Bottom Line
For those who want to maintain cash flow flexibility, the best option is a 30-year mortgage. A certain amount of peace of mind comes with a 30-year mortgage, too, since you know that you might be able to handle a payment if an emergency strikes. However, if you want to lock in a lower interest rate, paying less and getting out of your mortgage sooner, a 15-year mortgage might be the better choice.
What do you think? 15-year or 30-year? Why do you have the mortgage that you do?
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Get a 30 year mortgage but pay it down in 15 years. That way you get the best of both worlds. You pay an effective interest rate that is lower than your 30 year, you're done in 15 years and you have no obligation to make higher payments if something comes up. It just takes more diligence.
We choose the 30 year mortgage for now so that we could pay more when we feel we truly have it. The goal is to pay it off but going with the 15 though it would have be a lower interest rate we just couldn't cover it. We plan to refinance in the coming years and go with the 15 only if the rates are lower or the same as we currently have. If not we'll just make larger payments toward principle.
I am so happy you wrote this article the way you did and for the choice you, the author, made because it sets a good example. My opinion is to ALWAYS CHOOSE THE 30-YR OPTION.
Why? For exactly the reasons you mentioned above: You can always pay the 15-yr amount AND you're able to withstand a down-turn in the economy.
If you had asked this question of me five years ago, I would have said "it depends." I had a 15-yr mortgage and paid my house off early. BUT, I have since watched people I know and love have to sell their property because they were in a short-term loan, had equity but lost a job. No lender would refinance them but since they could no longer afford the payment, they were forced to sell a home they wanted to keep. This just heaped loss upon loss.
Be smart...just make extra payments.
Ree ~ I blog at EscapingDodge.com
My credit union offered a 20 year mortgage which I'm on schedule to pay off in 15 years.
During tight months, I was glad to not have to make the extra prepayment. But I'm thrilled with the thousands I'll be saving in interest.
Another thing to think about is where else the extra money might go if you opt for the 30-year over the 15. My wife and I recently refinanced our primary residence and got 3% rate on a 15 year loan. However, after we closed I had a little buyer's remorse, because we have a rental property that we are paying 6% and can't refi due to lack of equity. If I had taken the 30-year on the primary residence and paid a LITTLE higher interest, I could have used the extra money to pay down the rental property, and when it was paid off I could have then redirected money that is servicing that loan back to the mortgage on the primary residence. They'd have both been paid off faster, and we'd have saved more money. Even if you don't have a rental property like us, a fifteen year mortgage is money you aren't putting in your IRA or 401K. The money you save with the shorter mortgage may be lost by NOT investing the difference in the market.
I chose a 30-year mortgage, after doing days and days of intensive math about the benefits of investments and inflation over that of paying a mortgage off quickly. I have a table with the numbers for those who are interested (http://giddingsplaza.com/2013/05/13/part-2-get-rid-of-your-debt-today-an...). Any other kind of debt is poison, but mortgages, because of their low interest rates and long-term nature, are a great way to free up your money to use for other investing.
I think if you can afford to go with the 15 year, you should get that. Many people fall into a trap where they say that they'll just pay the 30 year with payments that would allow them to pay it in 15 (giving them the flexibility) but then find some reason or another to slow or eliminate the extra payment.
How about choosing the right house first? We were looking at 2 houses: one was $400K where we could only afford the 30-yr mortgage payments, one was $230K where we could afford the 15-yr payments. We decided to get the $230K house and the 15-yr mortgage. Looking at the amortization tables and seeing the total amount of interest paid was the main reason we went with the less expensive house and the shorter mortgage term. We just couldn't justify giving the bank so much money in interest! We are on track to pay off the house in 6 or 7 years and it's going to feel great! Also, I'm not sure we would've been disciplined enough to invest the difference between the 15-yr and 30-yr payments. That money would've been spent on random stuff and we wouldn't have been any better off financially.
Money is so cheap, one would be crazy to try and pay it off early. Take the 30 years and make your fixed payment with inflated dollars.
Great article! Many people like the security of the 30 year mortgage and then paying extra each month. This is a good plan as long as you try to stay consistent with the extra payments. If not, go with the 15 year mortgage if the monthly payment is affordable.
We had a fifteen year mortgage but we paid that early (a year or two early). Now we are free and clear and in our 40s. I would say always go with a 15 year. It is so worth it. If you are not buying more than you can afford, a 15 year is do-able. We did it on one income most of the time.