When you mosey on down to the bank to get a mortgage or refinance, you’ll be offered a number of loan alternatives. The main two are a 30-year mortgage or a 15-year mortgage.
The 30-year loan has the highest interest rate because it presents the lender with the most risk – they are on the hook for that money for 30 long years.
With a 15-year loan, your interest rate will be lower because the risk to the bank is lower. But your payments will be higher as a result of the shorter period over which you’ll repay the money.
Because the interest rate is lower, the 15-year loan will save you money in most cases over the life of the repayment period.
But does that mean it’s always the best deal for you? Not always.
As I said, it’s great to save interest but remember those monthly payments are higher.
Can you afford that higher monthly nut? If not, you may even risk damaging your credit score or worse – losing the property.
Because you don’t want to do either, you may decide to buy a less expensive house; one with payments you can afford.
While affordability is always my number one concern – it is not the only concern.
What if, in order to buy a house that you can payoff in 15 years, you have to buy in an area you don’t dig or a house that is too small for your situation? That’s no good either.
In this case, a 30-year mortgage could actually be much better.
Keep in mind that with a 30-year mortgage, you can always make higher monthly payments if you want to pay it off faster. True, you don’t get the lower rate, but you get a lot more flexibility.
This could be a life saver if you suffer adverse financial conditions or the economy takes a downturn down the road.
If that does happen, you simply go back to your original (lower) payment schedule.
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.
And keep another thing in mind. If you take out a 15-year mortgage and then want to refi later on, should your budget get tight or because you hit some financial setbacks, you may not qualify at that time.
If you qualify now for either one and you are worried about losing your job or getting hit with some other financial emergency, having a 30-year mortgage might come in handy.
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.
This also assumes you have a pretty good reason for figuring that your income will be stable and you’ll be able to afford those payments over that 15 years.
If those two conditions are present, you’ll probably save a lot of dough by going with the 15-year loan.
How do you know if you can afford the payments?
Some people like to use rules of thumb like spending no more than 25% of your income on housing. I think there are better ways to figure this out.
When I meet with people who want to buy a home or refinance, I ask them how much they are spending now on housing and how much they save each month.
Then I ask how much the new loan will cost them (including everything like taxes and insurance).
If, for example, the new arrangement will cost them an extra $1200 a month and they aren’t saving at least $1200 a month now, I know we have a problem – and so do they after we discuss it.
This isn’t rocket science Pilgrim. Do the numbers and be honest. You’ll know what to do.
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.
What term mortgage do you have? Why?