Choosing Between a 30-Year Mortgage and a 15-Year Mortgage
If you're shopping for a new home and looking at loan options, you've probably seen lender offerings of both the 30-year mortgage and 15-year mortgage. But apart from one being twice as long as the other, what distinguishes one loan type from the other?
There are four main differences between a 30-year mortgage and a 15-year mortgage: the monthly payment, the interest cost, the repayment period, and the rate at which your home can build equity.
Read on to see how the comparison breaks down and get some tips for deciding which type of mortgage is best for your situation.
Since it compresses the repayment of your home loan into a shorter length of time, a 15-year mortgage will naturally require higher mortgage payments each month. By contrast, stretching out your home loan repayment over 30 years means lower monthly payments, leaving you with extra cash that you might be able to put toward savings or other living expenses.
Let's look at how the monthly payment would differ on a $250,000 mortgage. Since 15-year mortgages generally have slightly lower interest rates, we'll imagine a rate of 4 percent for the 15-year loan and 4.5 percent for the 30-year loan. In this scenario, your monthly payment on the 15-year loan would be $1,849.22, while the payment on the 30-year loan would be $1,266.71 a month.
Deciding between a longer term with a lower monthly payment and a shorter term with a higher payment is something only you can decide. Look closely at your finances and speak with your mortgage loan officer about what the best option might be for you. Remember, if you choose a lower monthly payment, there's always the option of paying more each month when you're able to.
While the 30-year home loan has some edge when it comes to the affordability of the monthly payments, the 15-year loan comes out ahead when you add up the interest expense. That's simply because the shorter repayment term at a lower interest rate results in less of a total interest charge. On that $250,000 mortgage in the previous example, a 15-year loan at 4 percent would accumulate about $43,600.95 in interest charges over the first five years and a total interest cost of $82,859.57 over the life of the loan. The interest on a 4.5 percent, 30-year loan for the same amount would be $53,897.59 for the first five years and $206,016.78 total.
The fact that a 15-year mortgage has a shorter payback time than a 30-year mortgage is obvious, but it's worth taking a moment to point out how this difference might affect your overall financial planning. On the one hand, paying off your mortgage in half the time could allow you to devote more funds toward accelerating your retirement savings, paying for your kids' college education, or maybe even purchasing a second home in your favorite vacation spot. On the other hand, while it takes longer to pay off a 30-year loan, the savings on your monthly payment can be used to meet ongoing or short-term financial obligations or invested for long-term growth.
Your income, cash flow, and personal financial goals will factor into which choice makes the most sense for you.
Home equity is the difference between your home's current market value and any debt against the property, such as a mortgage. The more you pay down that debt, the greater your equity. It's a financial asset you can leverage to borrow money or pay for retirement expenses in the future. The higher principle payments and lower interest charges on a 15-year home loan allow your equity to build up faster. With a 30-year loan, you're paying off the balance at a slower rate with initial payments consisting mostly of interest, so it takes longer to build equity in your home.
Which Loan to Choose
As you're weighing the pros and cons of each loan type, be sure to consider these factors.
- Your Income: If you're taking home more than enough to cover your basic expenses, it might make sense to choose a home loan that you can pay off faster — taking advantage of the chance to drastically reduce the total cost of your loan. However, if your income doesn't leave you with a lot of extra funds after covering the basics, or you're working in an industry with a high risk of layoffs, you might prefer a longer-term mortgage that keeps your monthly payments affordable.
- Your Savings: Do you have enough savings to cover your living expenses for several months in the case of a job loss, illness, or other financial emergencies? Are you able to regularly contribute enough to your retirement savings account for the maximum employer match? If the answer to either of these questions is no, then taking on the higher monthly payments of a 15-year mortgage may not be the best choice for you.
- Your Taxes: The interest you pay on a mortgage loan may be tax deductible. The ability to lower your tax liability over a longer period of time is one advantage of the 30-year mortgage. Make sure to consult your tax advisor regarding the deductibility of mortgage interest.
- Your Retirement Timeline: The closer you are to your planned retirement age, the less appealing a long-term home loan is likely to be. You may not want to be saddled with additional debt after you stop earning a salary.
Deciding the best way to finance your new home is a very personal choice. Think about how the impact of a 15-year mortgage and 30-year mortgage might differ in your financial situation, then speak with your mortgage loan officer for more guidance in choosing which one best fits your needs.