A 15-year mortgage is one of the popular loan terms second to a 30-year mortgage. Some borrowers opt for the 15 year mortgage because it saves them a significant amount of money in the long term.
The market today is filled with several types of mortgage products. The 15 year mortgage has its own set of advantages and disadvantages in comparison to the 30-year.
While both the products share similarities, the interest rate can be impacted by the borrower’s credit history and credit score.
Timely payments, length of credit history, and how many open credit accounts are the factors that determine the credit score, which is a numerical representation of how likely a borrower will pay back money owed.
Both a 15 year and a 30-year loan require adequate monthly income to cover the potential mortgage payment and other debts.
Both the 15-year and 30-year mortgages have fixed rates and fixed payments over their terms.
Let us look at the advantages of a 15-year mortgage against a 30-year.
Since the total interest payments of a 15-year mortgage are less than a 30-year mortgage it would cost less in the long run.
The cost of a mortgage is calculated on an annual interest rate and as you’re borrowing the money for half the term, the total interest paid will also be lower than what you’d pay over 30 years.
Short-term loans are considered less risky and cheaper by banks to fund compared to long-term loans, hence a 15-year mortgage comes with a lower interest rate.
Compared to a 30-year mortgage these rates can be anywhere between a quarter-point to a whole point lesser.
If the mortgage is purchased by Fannie Mae, one of the government-sponsored companies, you will end up paying less in fees for a 15-year loan.
Fannie Mae and the other government-backed enterprises charge loan-level price adjustments for 30-year-mortgages.
These fees are applicable to borrowers who have lower credit scores and make smaller down payments.
A lower mortgage insurance premium is charged to 15-year borrowers by the Federal Housing Administration (FHA).
Lenders require PMI when you put a down payment that is smaller than 20% of the home’s value.
PMI protects the lender in case you default on the payments. It is charged as a monthly fee added to the mortgage payment, and it ceases once you pay off 20% of your mortgage.
Financial planners consider a 15-year mortgage a type of forced savings as the monthly payment is higher for a 15-year mortgage.
So instead of taking the monthly savings from doing a 30-year and investing the funds in a money market account or in the stock market, you’d be investing it in your house, which over the long run is likely to appreciate.
Even after the interest saved with a 15 year mortgage, borrowers should consider a few disadvantages before plunging into the term.
As the 15-year mortgage loan needs to be paid off in half the time it has a higher monthly payment than a 30-year.
For instance, a 15-year loan of $250,000 at 4% interest will have a monthly payment of $1,849 against $1,194 for the 30-year.
So the 15-year monthly payment is about 55% higher than the 30-year for the same amount at the same rate.
Because of its higher payment, the buyer might be limited to a more modest house than they would be able to buy with a 30-year loan.
With the same example mentioned above, if the mortgage lender will only approve a maximum of $1,500 per month.
The borrower would need to buy a house that is cheaper a $200,000 mortgage at 4%, for 15-years, turns out for a payment of $1,479.
Whereas a 30-year loan would result in a $1,194 monthly payment that is under the $1,500 limit approved by the lender, the 30-year loan might allow the borrower to buy a larger home or take on a bigger mortgage.
So a 30-year mortgage for a $300,000 home would cost $1,432 per month, which too is under the $1,500 maximum and allows you to take on a larger loan by getting a bigger home or a better location.
The higher payment requires higher cash flow and one year’s worth of income in liquid savings.
The higher monthly payment means a borrower would have to let go of the opportunity to build savings or save for goals like college tuition for a child or his retirement.
Like a 30-year mortgage a 15-year mortgage, too is a home loan having the same interest rate and monthly payment for the life of the mortgage.
Depending on your financial situation and goals you can decide if you want to opt for a fixed 15-year or 30-year mortgage.
A homebuyer can save significant money over the length of the loan with a 15-year mortgage because the interest paid is less than in a 30-year mortgage.
Refinancing into a 15-year mortgage when you are halfway through your 30-year mortgage, may lower your interest payments while still paying off the loan in the expected amount of time.
Because in a 15-year loan the payments are significantly higher, if buyers cannot keep up with the payments due to loss of job or change in income they risk defaulting on the loan.
Buying a home is the biggest purchase you are ever going to make in your lifetime. So it depends on what kind of mortgage you get.
The ideal situation is to pay for a home in cash, but a lot of people don’t have that kind of money lying around.
Hence, people opt for a mortgage, which is a loan against your home, using your home as collateral.
If a borrower is unable to pay the mortgage, banks have the right to foreclose the house, which is kept as collateral. 30 year mortgages are the most common.
About two-thirds of applications are for 30 years mortgages.
And upon final closing, the statistics show that the 30 year mortgages are used 86 percent of the time by the borrowers whereas 15 year mortgages might sound an odd choice because 30 year mortgages are more popular.
Let us learn the pros and cons of both 15 years mortgage and 30 years of mortgages.
The interest rate on a 15 years mortgage is lower than 30 years mortgage. The reason for this is 15 years mortgage is less risky a loan compared to 30-years. It is less risky for a lender because the term is shorter.
If the term is more concise, there is a high possibility for fewer things that can happen to you like job loss, sickness, etc.
So a shorter termed mortgage (15-years) is looked at as less risky to the banks and lenders. The interest rates are also typically 0.25% to 1% lower than the 30 years mortgage.
Since the tenure for a 15 years mortgage is short compared to a 30 years loan, a borrower can pay off the mortgage for the same house in half the time.
If budget is not a constraint for you, making an additional payment towards your principal every month may help you to pay off the loan way before 15 years.
The principal of the loan is the amount that you borrow, and your lender or bank will charge interest on top of the principal amount. There are two parts to your mortgage the principal and the interest.
With a 15 years mortgage, more of your monthly payments go towards principal paydown, which means you are paying off the loan faster as opposed to a 30-years loan.
The one most significant con of choosing a 15 years mortgage has a higher payment every month.
So it just makes logical sense, if you are getting a mortgage and paying it off in 15-years instead of 30-years, your monthly payments would be higher because you are paying off the same loan amount in less time.
Using most of your money for quick mortgage repayments could lead to it not being available for other investments a higher return on stock investments.
Because of the outstretched tenure, the payments on a 30-years mortgage are more economical compared to a 15 years mortgage.
The lower payments allow you to purchase a home that you can initially afford compared to a 15 years mortgage because your payments are stretched out over 30-years.
This also frees up more funds for additional investments. As long as you are earning more interest in your investments than what the interest is on your mortgage, it means you are getting a positive return.
For Example, if your interest rate on the mortgage is at 4 percent, and the interest that you are getting on your investment is 6 percent.
There is a difference of 2 percent that you are netting throughout that 30-years.
Since the tenure is stretched to 30 years, it takes a longer time to pay off the loan. It is 15 years more that you continue to pay the mortgage when compared to a 15 years mortgage.
Due to this, it may be possible that you are still paying until the time of your retirement.
Anyone would like to pay off the mortgage before retirement as after retirement, and the mortgage payment may be one of the most significant parts of your expense.
In the case of a 30 years mortgage, the majority of your payment for the initial years goes towards the interest part of your mortgage. Because of this, you are not building enough equity in this process.
There are definite advantages to both 15 year mortgages and 30 year mortgages. But keep in mind, it is called personal finance for a reason. There is no one size fits all. Personal finance should be particular to your life and life situations.
Talking to your trusted loan officer might give you more information on which one suits best according to your situation.