There’s a lot to think about when buying a house. Deciding between a 15- or 30-year-mortgage may not seem like something you want to use a lot of mental energy on when everything else is so overwhelming.
But actually, it’s one of the most important decisions you will make, one that will determine your financial well-being for decades to come. In fact, for the rest of your life. That’s not hyperbole, it’s a fact.
There are advantages and disadvantages to both, depending on everything from how you see your career arc, whether you have kids, if you expect an inheritance or some other windfall, and how you plan to retire. If you’re 10 or 20 years from retirement age and buying a house, the decision is even more crucial.
You don’t have to be a financial whiz to figure it out. Weighing the advantages of 15-year-mortgages against 30-year-mortgages is as easy as taking a look at where you are, and where you want to be.
What Is a 15-Year Mortgage?
It’s a simple concept: 15-year mortgages are paid off in half the time of the traditional “holy grail” of finance, the 30-year mortgage. While 30-year mortgages are still common, some homebuyers are opting for a 15-year payoff period.
- Lower interest rates. Lenders are always computing risks, and the risk of someone defaulting on a loan over the course of 30 years is greater than over 15. That’s one reason why interest on a 30-year loan is higher than on a 15-year one. The difference isn’t huge – anywhere from a quarter to a full percentage point – but on a long-term loan, the lower interest rate can be a significant difference in your overall payback amount.
- Lower interest payments. Mortgage interest is computed on the outstanding balance of a loan. Because of that, the faster you pay off the principal of a mortgage, the less money you’ll spend each month on interest.
- Lower interest overall. Since a 15-year mortgage is repaid in half the time, that’s 15 years you won’t be paying interest, which represents some real savings.
Monthly payments for a 15-year mortgage are a lot higher than 30-year mortgages, and if interest rates were higher, the monthly payment on the shorter term could be painful. But historically low interest rates have made 15-year mortgages increasingly popular.
Low 15-year mortgage rates – averaging 3.28% to 3.44% in January 2020 – save money, and buyers interested in paying down principal quickly often can do it without breaking their bank accounts.
Buyers interested in getting the best interest rate on a mortgage should strongly consider the 15-year option, keeping in mind that everyone’s situation is different and the benefits of a 15-year mortgage should be weighed against other factors.
Pros and Cons of 15-Year Fixed Mortgages
If 15-year mortgages were for everybody, 30-year mortgages would quickly vanish, but they haven’t. The affordable monthly payments on a 30-year mortgage make them the go-to for 90% of homebuyers.
On the other hand, people whose budget can survive a bigger bite each month, may like the benefits a 15-year mortgage can bring such as low interest rates. Interest rates on a 15-year mortgage averaged 3.28% to 3.44% in January 2020.
Pros of 15-year Mortgages
- Paying less interest on a 15-year mortgage can save borrowers a bundle over the course of a loan.
- The higher payments can act as a forced savings plan. People who find it hard to stick to a budget may be wasting the money saved with a 30-year mortgage on trips to Vegas or 200 pairs of shoes. Every dollar that goes toward that mortgage’s principal comes back to you if you sell the house.
- Lower interest rates that range from a quarter to half a percentage point may not seem like a lot, but it means more of your payment is paying off the principal – what you actually owe –rather than interest.
- Paying off a house in 15 years removes what’s likely the biggest line item in your monthly household budget in a relatively short amount of time, giving you more disposable income.
- If you don’t plan on living in your home for three decades, the shorter-term mortgage means more equity in the home when you sell it, and therefore more of a profit.
Cons of 15-year Mortgages
- The higher monthly payment may be too much for many people’s budget. For example, not including taxes and insurance, in January of 2020, you would pay approximately $1,411 per month for a 15-year, $200,000 loan. A 30-year, $200,000 loan (without insurance and taxes), would be $898 per month. That’s a difference of $513 per month.
- There’s more flexibility with a 30-year mortgage. You can treat is as if it were a 15-year mortgage by paying twice as much every month, with the extra going to reduce the principal. But when money’s tight, you can go back to the lower 30-year payment.
- The lower monthly payments of a 30-year mortgage may help you afford a larger home.
15-Year Mortgage vs. 30-Year Mortgage
While there are a lot of factors that go in to deciding whether to get a 15-year mortgage or a 30-year mortgage, the three major points to keep in mind are:
- amount of time it takes to pay off each mortgage
- interest rates
- total amount of interest paid
Here’s some math to illustrate the difference: Consider a $300,000, 30-year loan that comes with a 4% interest rate. If the homebuyer stuck to the required monthly payment over 30 years, he or she would pay $215,609 in interest. By contrast, the total interest on a similar 15-year loan at 3.25% would be $79,441.
The rub comes in the monthly payment. The 15-year loan payment would be $2,108 exclusive of a required escrow payment for taxes and insurance. The 30-year loan would cost $1,432, nearly half the monthly payment of the 15-year loan.
Though 30-year mortgages still rule, 15-year loans have gained ground as homebuyers weigh their advantages. They help build equity quickly as you pay down principal due on the loan, and they offer long-term interest savings that result from not making payments for an extra 15 years.
By contrast, buyers pay mostly interest each month during the early years of a 30-year loan, giving them little to show for the property if they decide to sell it.
Comparing Mortgage Terms (i.e. 15, 20, 30 year)
Is a 15-year Mortgage Right for You?
Fifteen years is a long time, and 30 years is most of a working person’s career.
When considering what kind of mortgage is right for you, keep the future in mind, particularly what will happen once your working years are done and, if you have kids, what your plans for their future are, too.
If you have a lot of working years ahead of you, things to keep in mind are what kind of income increases you expect over the years and whether you have an inheritance or other windfall coming. No matter what your age, retirement is also a factor. If you’re nearing retirement age, the decisions on what length of mortgage to get become more specific.
Consider these factors when deciding if a 15-year mortgage is the right call.
Are you in a career that has steep income increases over the years, or does your field have small increases? Do you plan to change jobs often to increase your paycheck? How much more do you realistically think you might earn during your working career?
If you’re confident your income will grow faster than your expenses, a 15-year mortgage might be the best option, since with each passing year your mortgage payments will be a smaller percentage of your income.
If you’re expecting a sizeable inheritance or other windfall before the mortgage is paid off, there are benefits to a 15-year mortgage, but the 30-year mortgage also may not be a bad option. Consider the amount you’re expecting, and when.
You could opt for a 15-year mortgage, knowing in the long run you’ll have the inheritance to apply to a retirement account.
The 30-year mortgage option would save you money in the short term, then you could pay off most or all of the balance with the inherited money.
If you’re not expecting a windfall and you’re not sure how much your income might grow over the years, opting for a 30-year loan makes sense. Even if you’re confident now that a 15-year mortgage is a good option for you, circumstances can change. Job loss, illness, house fire, family emergency – even the most well-maintained budget can take a hit from the unexpected things life throws at us.
When that happens, large payments that seemed manageable could end up being a burden. It’s important to make sure you have some type of fund for emergency situations that will help you keep up to date on mortgage payments. If making the larger monthly payments and maintaining an emergency fund are beyond your budget, you may want to opt for a 30-year mortgage.
Some people want to pay off a mortgage before their children go to college. That’s fine, since it will take a large expense out of your budget at a time you’ll be taking on another big expense. But keep in mind that there are alternative ways to save for college, including tax-free 529 savings plans.
The smaller monthly payments with a 30-year mortgage may give you extra money to sock away in a college account that can grow and earn interest over the years.
As important as focusing on your mortgage during your working years is, building retirement savings is more important. And, like paying off a mortgage, retirement savings is a long-distance run.
Never opt for higher monthly mortgage payments at the expense of a retirement plan. Paying off a 15-year mortgage could put all your money in home equity. Though it’s possible to borrow against that investment with a home equity loan or line of credit, you’ll have to pay interest on what you borrow. And it’s easier to access money in a retirement account than it is to extract equity from your home.
Opting for a 30-year mortgage might allow you to also put more money in an IRA or 401(k) plan, which will grow tax-free for years until you can withdraw it without penalty.
If you’re in your 40s or 50s and buying a home, things get trickier. A 15-year mortgage could allow you to pay off your mortgage before you retire. On the other hand, some people in retirement rely on the mortgage interest tax deduction, and that’s not available once the mortgage is paid off.
A financial planner can help you crunch the numbers and decide what’s best for you as you near retirement.
The Burden of Debt
If you can easily afford the monthly payments, want to save on interest and be out from under the burden of debt, the advantages of a 15-year mortgage make it the way to go. The savings are considerable, but only if it doesn’t strain your budget. Your mortgage shouldn’t impoverish you.
Before you opt for a 15-year mortgage, make sure you are not giving up anything more important so you can make the larger payments.
A safe rule is that housing shouldn’t take up more than 30% of your monthly budget. Calculate how much money you can afford for housing each month and don’t exceed it. The number you come up with, keeping all the pros and cons in mind, will determine if a 15-year mortgage is right for you.