It’s a deceptively simple question: do you want to own your home in 15 years or 30? We all know the pros and cons of each term — the shorter mortgage term has higher monthly payments, but you build equity more quickly and pay less over the life of the mortgage, whereas the 30 year term frees up money each month to be used elsewhere. But how do you know which is the right term for you? Here are some questions to ask yourself to help you determine which mortgage term to choose.
How much house do you need?
I suspect that fewer people make this mistake now than before the housing collapse, but it is important to remember how foolish it is to be house-poor. A “benefit” of the 30-year mortgage is the fact that it allows you to purchase a more expensive home that you could not necessarily afford with a shorter term. But it’s one thing to make a slight stretch to buy the right house and it’s quite another to reach far beyond your means.
It makes good sense to purchase a home you could afford even with the monthly payment of a 15-year mortgage. Then you will have the flexibility of deciding which is right for your budget, rather than having to take the 30-year option.
How long do you plan to spend in the house?
If you think you’ll stay in the house for 5 years or less, then you’ll need to weigh the consequences of spending more per month (and therefore having more equity available when you sell) to those of keeping your monthly housing payments low while you are anticipating some sort of move in the future. Will you need the equity more later or the extra money in your monthly budget now?
If you expect to stay in your home for the long haul, that also presents you with some choices. A 30-year mortgage gives you some financial leeway to either purchase a house you could grow into (i.e., a more expensive home) or spend money on renovations that will make a more modest house become yours. But paying off that mortgage in 15 years means that you will have a “windfall” of extra money each month while you are still several years from retirement.
How much financial flexibility do you need?
If you can swing the payment on a 15-year term, will that leave you with enough wiggle room at the end of each month? It can be easy to crunch the numbers and get dollar signs in your eyes when thinking about how much you will save in interest over that time. But don’t forget that you have to live on your monthly budget, and the difference between a 15- and a 30-year term might be the difference between a night at the steak house once a month and grabbing burgers at the local drive through.
For some homeowners, taking a 30-year mortgage and sending double payments each month is a happy medium that still allows for flexibility if life sends you a financial curve ball — or if you just miss the extras and instead send in one payment that month to pay for some of the luxuries.
Unfortunately, there is no easy answer to the 15 or 30-year mortgage question, as it all depends on your circumstances. However, making sure that you think through the consequences of either term will help you make the best money decision for your life and budget.
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The 30 year mortgage is an obvious choice where rates are at this time. There is not a huge difference in interest savings when you compare 15 to 30 year rate versus the flexibility of a 30 year note. If you make the same principal payments on a 30 year mortgage that the 15 year mortgage requires on a $200,000 loan with .75% rate difference it would be paid in 16 years 1 month vs 15 years. You would pay $19,000 more in interest but enjoy the flexibility of a PI payment of $984 vs 15 years $1430. This is what we call a no brainer considering the average person moves well before a loan is paid off. I always consult my clients to enjoy the flexibility of a home loan compared to strapping yourself to a mortgage payment. Where else can you free up nearly $450 a month if all h*** breaks loose!
It just takes discipline to send in the extra and a responsible lender who will not penalize you for doing so. The above PI payments were taking into account a 4.25% vs 3.5%.
There are huge savings available by using a 15-year mortgage, beyond the obvious fact that you will own your home much sooner. The interest rates on 15-year mortgages usually run about 0.75% lower than those for a 30-year loan. A person borrowing $250K at 3.5% today would pay over $154K in interest to the bank over the life of the mortgage. Borrowing the same amount at 2.75% for 15 years results in paying only $55K interest. A savings of over $100K! The tax deductions also still run about the same for both loans, because they both exceed the standard deduction on the early years only.
Of course, not everyone can afford the higher payments for the shorter loan, but some smart decisions such as buying or building a smaller home, or saving a larger down payment – can make the payments more manageable.
I have a book underway that will explore these topics – essential for the largest financial decision most of us will ever make. The rough title is: “The Real Cost of Home, and how to save a fortune buying it”. Contact me if you are interested in an early copy.
I went with a 15 yr loan. That way I was forced to purchase a less expensive house because the payment was larger. With a 15 yr loan you will also get a lower interest rate than a 30 yr loan. So 10 yrs have gone by and my house will be paid off in 5 yrs. Feels real good, especially since the last Recession knocked 40% off the home’s value. I saved a few hundred thousand dollars in interest going with the shorter loan.
Something that many people over look is that your interest payments on a 30 or 15 year mortgage are primarily front loaded. That means that in the first five to 10 years of your mortgage you are paying a huge percentage of the over all interest up front. Keeping this in mind and considering that you’ll likely not stay in your house for the full 15 or 30 year term, both loans will cost you nearly the same amount in interest during the short term.
Compare the following amortization schedules. You’ll see that while you ARE paying the principal down faster with the 15 year loan ( because a portion of your larger payment goes to principal) during the first 7 years of either loan you are paying nearly the same amount of interest to the bank. It’s important to understand this especially if you are considering selling within the first 5 to 10 years or refinancing after say 10 years or so. The bank has already gotten it’s cut and your over all interest rate if you do not go the full term is much higher than the 4.5%, etc…
$100,000 4.5% 30 yr
Year Beginning Balance Interest Payment Ending Balance
1 100000 4467 6080 98387
2 98387 4393 6080 96699
3 96699 4315 6080 94935
4 94935 4234 6080 93089
5 93089 4149 6080 91158
6 91158 4061 6080 89138
7 89138 3968 6080 87026
$100,000 4.5% 15 yr
Year Beginning Balance Interest Payment Ending Balance
1 100000 4402 9180 95222
2 95222 4183 9180 90225
3 90225 3953 9180 84998
4 84998 3713 9180 79532
5 79532 3462 9180 73814
6 73814 3199 9180 67833
7 67833 2925 9180 61578
The rates are never the same so your comparison is worthless. 15 year rates are generally lower so you pay less interest despite the front loading you speak of.
Good ideas to consider. I like the idea of buying a home for a 30 year term that is smaller and then buying a bigger house in the future if you are in better financial standing.
I would add, if you plan on staying in the home 5 years or less, don’t buy a home right now!
Look at the news. It’s not looking good. The recovery is years away.
To leave room for the “unforeseen”, I usually would get a 30 yr and then make payments as long as possible as if it were a 7 – 10 yr loan…. The 30 yr lower payments meant I could have made payments even on unemployment. The 7 – 10 yr monthly payment rate made sure I paid if off very very soon…
And mortgage free is a GREAT feeling!
With inflation, and hopefully a rising income, the percentage of your monthly budget that your mortgage will take up comes down steadily by the year. The pinch of a shorter term loan is felt more in the first couple of years, since you would have factored in your ability to make repayment based on your current earnings and budget. With the passage of time, the load reduces. Of course, this is assuming that you don’t have a major negative change in your earnings. By going for a longer term mortgage, you are basically ending up pledging a part of your monthly budget for a longer time, in addition to paying a high interest component. In my opinion, in spite of the fact that it reduces your choices in terms of the prices that you can consider, and the fact that it puts a greater burden on your monthly budget in the short term, it probably still makes sense to go for a shorter term mortgage.
A 15 year mortgage combined with a mortgage payment <20% of your monthly income is a good metric to go by. the 30 year is a back-up option in case you live in one of those markets where a million dollar home is considered average.
One thing that I didn’t consider when I bought my house (before the economic collapse) was that you may end up moving for a job somewhere else and end up renting out your house. That’s what happened to me and makes my cash flow more negative than I want because I got a 20 year mortgage and rent doesn’t cover my mortgage and property taxes. It’s probably better in some cases to get a 30 year mortgage and pay extra.
UH2L
Try to have in your mortgage a clause that allows you to make additional payment of the loan without any cost, so if you get some extra money one day can you get pay off more on the mortgage. If you can do that then take a 30 year mortgage.
My credit union offered a 20 year loan with an interest rate right between the 15 and 30 year loans. When I refinanced last year, I had paid 7 years on my existing 30 year loan and the 20 year loan was a good choice, since the monthly payment turned out to be about the same. I pay extra on the principle when I can and plan to pay it all off in about 16 years, shaving a few years off of my original loan. Every family has to make the best choice for their situation, and you offer some terrific considerations.
It may also come down to how good of a budgeter you are. Frankly, I’m now. If you can be dedicated to making extra payments the 30-year gives you the most flexibility. But if you know you aren’t, the 15-year kind of forces to put the extra back into the mortgage.
And good point on the affordability side. We spent a little more because of the 30-year, although we needed a little more because of our family size. If we had gone the 15-year, it would be more than half-way paid off.