One of the decisions you have to make when you buy a home is often whether you want a more “standard” 30 year mortgage, or if you want a 15 year mortgage. What you decide, as with all things personal finance, depends almost entirely on your own situation, and where you stand with regard to your finances. You should also understand the implications of each type of loan.
Comparing 30 Year vs 15 Year Mortgage
30 Year Mortgage
As the name implies, your loan term will be 30 years with payments spread out over the term. The chances are that you will have a payment that is lower. Many people choose 30 year mortgages because, even if there is a small down payment, it’s often still possible to get a home that meets your needs with a monthly obligation that you can afford.
However, the downside to the 30 year mortgage is that the interest rate is often a little bit higher. So, you are paying a higher rate of interest over a longer period of time. This means that you end up paying more in the long run. If you get a mortgage for $180,000, with a 3.50% rate, after 30 years you will have repaid a total of $290,980.96 through your monthly payments of $808.28.
15 Year Mortgage
On the other hand, if you decide to get a 15 year mortgage for the same amount, but with a 3.05% rate, you will have monthly payments of $1,247.38, but your total amount repaid will be $224,528.41. Over the life of your loan, you will pay $66,452.55 less if you get a 15 year mortgage as opposed to a 30 year loan.
You build equity (i.e., your ownership of the house) faster with a 15 year mortgage than with a 30 year mortgage, so you receive a better value for your payments in a smaller amount of time. However, you do have to evaluate whether or not you comfortable making a mortgage payment that is more than $400 higher a month than what you pay with a 30 year mortgage.
If you have cash flow concerns, it makes sense to avoid the 15 year loan and choose the 30 year loan. On the other hand, if you are interested in paying off the home sooner, a 15 year mortgage can make more sense.
Getting a 30 Year Mortgage But Paying it Off in 15 Years
An option that is increasingly popular is to get a longer mortgage, but pay it off faster. If you have a 30 year mortgage, you have the benefit of having a lower regular payment. But there is no reason that you can’t put more money toward your loan if you want to, unless there is a prepayment penalty.
So, if you choose a 30 year mortgage, you can make a plan to pay it off in 15 years. Use a mortgage calculator to help you figure out how much you would pay with a 15 year loan, and then plan to make that payment each month, specifying that each month the “extra” should go toward principle reduction.
You have the benefit of being able to reduce what you pay overall, but you also have wiggle room for your budget. If you run into a rough patch, and you can’t afford the higher payments, you can make the “regular” payment that goes with the 30 year mortgage. You’ll have a bit of a budget breather, without worrying about falling behind on your house payments.
The downside to this approach, of course, is that you end up paying the higher interest rate that comes with the 30 year loan instead of the lower rate on a shorter term. However, even with this disadvantage, you still come out ahead of what you would pay if you had decided to stick with a more standard approach to the 30 year loan.
Bottom Line
Look at your finances, and consider your priorities. If you are more interested in maintaining monthly cash flow, get a 30 year loan. You can put more toward the principal later if your situation improves, or you can refinance to a shorter term and a lower rate later on. If you are more concerned with paying off your mortgage and becoming debt free quickly, choose the 15 year mortgage — as long as you can afford the higher monthly payment.
One should take a long, hard look at their budget before committing to a 15 year. Oddly, the difference from 30 to 15 rises as rates fall. (At 14% in the 80’s the payment rose by less than 12% to go 15 yr vs 30)
I suggest that one be sure to get their matched 401(k) deposits in, and then some, and be sure to have no higher interest debt. Then the 15 year may make sense. As always, good article.
@Joe – Good to see you here. My take on it is that the interest rate is so low now that it’s better to go with a 30-year mortgage. I personally like the greater flexibility and higher cash flow that comes with a 30-year loan AND I have an investment plan for the difference.
I have a 30 year mortgage that I will be paying off in 15 years this December by paying extra every payday. For those considering this route, make sure you find out if there’s a fee for paying early.