Think twice before you get a 15-year loan. As you consider buying a home, you will be presented with two mortgage options: a 30-year mortgage or a 15-year mortgage. The 30-year loan is considered “standard” by many, but there are those who prefer the 15-year loan. This is because the 15-year mortgage comes with a lower interest rate. That can result in saving a boatload of interest over the years. Is that reason enough to go with the 15-year mortgage?
How Flexible are Your Finances?
One of the biggest drawbacks to a 15-year mortgage is that it lacks a certain flexibility. In most cases when you get a 15-year mortgage instead of a 30-year mortgage, you either have to make a higher monthly payment or you have to settle for a smaller house. Once you get that 15-year mortgage, you are locked in – unless you refinance to a longer mortgage down the road.
If you decide on a 30-year mortgage, you might have a little more flexibility. You can get a larger home for the same payment. If you plan to stay put for a while, this can be an advantage.
Neal’s Notes: You might be drawn to a 15 year mortgage as rates are so low you might be able to keep your payment stable yet pay off your mortgage that much quicker. Good thinking but slow down. Sometimes a refi masks other problems. Make sure you are fully aware of all your reasons for refinancing before getting started. Sometimes a refi causes more problems than it solves.
For those who would get the same size home regardless, a 30-year mortgage offers payment flexibility. Your lower payment provides you with a little more wiggle room in your budget. You can make extra payments toward your principal and pay off the mortgage early if you want to.
This way you have the option to save some money on your mortgage, but if you run into some financial difficulty you can go back to the regular 30-year payment. This flexibility can be quite useful if you are concerned about what the future holds.
It is also worth noting that you may not be able to refinance your home to a 30-year mortgage if your financial situation changes. This is especially true if you don’t have a sizable down payment and if you are still in the early years of your mortgage before you have built up a fair amount of equity.
When a 15-year Mortgage Is Most Likely to Benefit You
A mortgage with a shorter term is most likely to benefit you when you plan to stay in your home for a longer period of time. If you know you will be settled in your home for many years, a 15-year mortgage can be the means of securing you a long-term stable home at a discount from a 30-year mortgage.
However, if you do decide to get a 15-year loan, it’s a good idea to make sure that the payments aren’t a stretch for you. Many recommend that you should keep your housing costs to no more than 30% of your net monthly income. However, you might be better off if you make sure to keep your payments to no more than 25% of your income. That way, you will have a little room in your budget in the event of a financial setback.
As with all financial decisions, it is up to you to determine what type of mortgage product is most likely to benefit you. Study the pros and cons and consider your financial situation. You might find the flexibility and affordability (especially if you pay it off early) of a 30-year mortgage more desirable than a 15-year mortgage.
Bill S says
At 48 years old I refinanced a 30 yr (23 left) and went with a 15 year with weeky payments. Due to 4 months having a 5th week I make an extra months payment ALL to interest each year. Now the house will be paid off so I can retire at 61 not 70!
So it depends on your point in life. If your starting out a 30 is best for fexibility and low payment. Starter house, final house, kids, college, retirement and future income need to be considered.
Later in life a 15 may be better if your down sizing or refinancing with lifes big expences behind you .
Neal Frankle says
Thanks Bill. Excellent point….and congratulations? Are you going to retire at 61? That’s pretty cool.
my2cents says
30 yr mortgage certainly offers the flexibility. But it also assumes that the home owner has the discipline to save the extral money from utilizing 30 yr term rather than a 15 yr term and use that money to pay for the mortgage if needed/wanted. It is almost always tempting to spend if you feel you have more money at hand. However, with a 15 yr term, you have your hand forced to spend the money on the house by paying more on the principal. That may not be a bad thing if you want to be debt free early in your dreamed house.
Neal Frankle says
Good point my2cents. Sometimes having more cash laying around is a dangerous thing. Thanks for pointing this out.
Bret @ Hope to Prosper says
Another option is to get the 30 year loan and then pay it off early. YOu don’t get the lower interst rate, but it’s a lot more flexible. I have been making bigger payments on my mortgage for 15 years and it will be paid off in 5-6 years. So, I will have cut 9 years off the term.
Twice, I have been unemployed and didn’t have to sweat it. I just made the minimum payments until I found a new job.
Neal Frankle says
Fantastic use of the 30 year option. Nice job. You are the honorary Pilgrim of the Month! I love it when people do this kind of thing.
Bill says
It looks like some people totally missed the point of this article. The comparison being made is a 15 year mortgage versus a 30 year mortgage with accelerated amortization. That allows you to directly compare the extra cost of the 30 year mortgage against the option of making lower payments. I think a few concrete numbers would help to illustrate.
For a $200,000 mortgage I compared a 4.5% 15 year against a 4.75% 30 year.
The 15 year has a payment of $1529.99, the 30 year is $1043.29. If you prepay the 30 year by $486.69 a month the payment for each is the same. The cumulative interest payments for the 15 year mortgage are $75,397.58, the cumulative interest for the 15 year is $82,192.86.
The question is then. Would you pay $6795 more for the option to reduce your payments by $500 a month if necessary? Keep in mind that the $6795 extra you are paying isn’t due for another 15 years, from months 181-185 to be precise. The present value of those payments are only about $3,700. Would you pay $3700 today to buy the option to reduce your 15 year mortgage payments by $500 a month at any point? It seems like a pretty cheap option to me and I intentionally chose a 30 year mortgage for my home to get that extra flexibility.
This is just an approximation, if the 15-30 rate spread is less than .25% it would be cheaper, if it is more the option would be more expensive. I also ignored the extra tax benefit you get from the 30 yr which will reduce the option cost by approximately your marginal tax rate.
Hunter says
The 30 year loan definitelyoffers more flexibility. Without pre-payment penalty, you can ammortize a 30 year loan at whatever schedule you like. The interest rate is too heavily weighted in mortgage decisions, I don’t think it should be the only reason to go for a shorter term.
Cam says
I think 30 year loans are the real estate scam, not 15 year loans.
You borrow money for 30 years @ 6%. 20 years in, you finally start to pay more principal than interest but by that time, you’ve already paid the bank the original mortgage amount in interest and you are only half way through your principal!
Scott Messner says
I have always been told to limit your housing costs to 25% of your net monthly income. 30% seems to be stretching it.
15 year fixed mortgages are the way to go if you can do it. You will save a lot of money when compared to a 30 year.
krantcents says
You are absolutely right! Too many people factor in the raise they expect next year to feel comfortable with the payment. That is a mistake, because you may not get it.