15-year or 30 -year Mortgage?
So many factors and decisions go into buying a home. Figuring out the type of home to buy, finding the right neighborhood, going through the inspection, and investigating types of loans are all part of the process. And then after all that, home buyers must decide on the length of the loan.
Whether buying a home or refinancing one, the most common and popular loan lengths are 15-year and 30-years. While it may seem daunting to make a decision that is more than a decade in the future, it’s also an important decision that should be based on the stage of life, amount of down payment, and type of loan.
What are the similarities between 15 and 30-year loans?
Structurally the loans are identical. Whether it’s an FHA loan or conventional loan, the paperwork is the same and the information the lender will need is the same. The basic steps toward obtaining the loan will be identical. And either loan is usually at a fixed rate which means the home buyer will know the monthly payment for the term of the loan.
What’s the difference?
The most obvious difference between the two is the amount of time it’ll take to pay the loan off and the interest that is paid.
Assuming neither are paid early or refinanced, one will be completely paid in 15 years while the other will take three decades. But paying for a home in 15 years might not be possible for some home buyers.
A shorter loan will have a lower mortgage rate but will also have higher monthly payments. Beyond monthly payments, homebuyers need to budget for property taxes, insurance, and any other expenses which will likely be rolled into the mortgage payments.
While stretching out the cost of home purchase may seem more manageable over 30 years, that also means paying more in interest and an overall higher amount.
Benefits to a 30-year loan
For families who are at an earlier stage of life or who are buying a home for the first time and intend to stay in the home for an extended period, a 30-year mortgage may be the best option.
A lower home payment may allow budgeting for things like education, a business investment or home repairs. Because the home payment is smaller, homeowners can more easily fit the payment into their monthly budget and still be able to afford other needs.
When exceptionally low-interest rates are available, it may be more profitable to put the savings from a lower mortgage payment into an investment that has a higher rate of return than the amount of the interest. Investing the money may be more beneficial long-term than home equity.
One other benefit to consider with a 30-year loan is the size of property that home buyers may be able to purchase. Those who are unable to make the larger payments with a 15-year loan may be able to afford a 30-year loan on the same property. The equity involved with a larger property may also make that purchase worthwhile.
An unexpected benefit to a 30-year loan is the increased tax deduction. Because a longer loan requires paying more interest, that means a larger itemized deduction.
Benefits to a 15-year loan
If the higher monthly payments are affordable, then a 15-year loan might make sense. The loan will be paid more quickly and at a lower interest rate. A 30-year-loan requires a higher interest rate because it’s seen by lenders as a greater risk.
A shorter mortgage also means that more money will go towards the home’s principal rather than interest, building home equity more quickly.
Someone interested in selling a house in a shorter time frame or someone who is able to make a larger down payment may prefer a shorter loan. If a home is purchased in an up-and-coming neighborhood, or a hot market, the home buyer may be able to resell within even a few years and recoup a greater amount of money with a shorter loan because more of the payments are going towards the home’s principal versus paying interest.
Older home buyers who plan to live in their home after retirement may want a shorter loan as well. Then they can plan to pay for the home before retirement and won’t be stuck with a monthly mortgage payment.
How to shorten either loan length
Regardless of which loan is selected, there may be an opportunity to repay the loan early. Some mortgages have no penalty for making additional payments.
This could mean a loan is repaid before the set 15- or 30-year loan length. It gives home buyers the freedom to pay the loan earlier. Because the payments are voluntary, it reduces the amount of principal owed without the homeowner having to commit to a monthly payment. Then if someone encounters a financial hardship they’re still able to make the minimum payment.
How to decide?
Homebuyers should look at more than just the bottom line of the mortgage amount. It’s not simply the loan that the buyer will need to budget; they’ll also be paying for insurance, property taxes, utilities, home maintenance, homeowner’s fees, and more, just for the home.
Factoring in all other expenses, such as food, clothing, education, and automobile, a home buyer should be able to make a more educated decision about a 15-year versus a 30-year mortgage.
First, check with the lender and get a detailed idea of what each length of mortgage entails, including estimated additional costs in escrow. Knowing exactly what amount will be expected each month will help with the decision.
Also, examine what amount each month will go towards interest versus principal. Then look at all other expenses as they currently exist and what future expenses might occur. Some expenses, like medical or home repairs, might be unexpected but others, like children and automobiles, can be budgeted. Once home buyers have a good handle on their future expenses, they can better see what length mortgage will better fit in their lives.