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?
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.