What Is a 15-Year Mortgage?
As the name suggests, 15-year mortgages are paid off in 15 years, half the time common with other home loans. For generations of American homebuyers, paying off a house in 30 years was the holy grail of finance. It still is, but a growing number of buyers 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 the cost.
- Lower interest payments. Mortgage interest is computed on the outstanding balance of a loan. For that reason, the faster you pay off the principal owed on a home loan, the less money you will spend each month on interest.
- Lower interest overall. Since a 15-year mortgage is repaid in half the time, there are many years that you would be paying interest that you won’t be. Those are real savings.
Historically low interest rates help explain the current popularity of 15-year mortgages. The downside for 15-year loans is that you pay more each month than you would for a 30-year loan.
The pain of doing that would be much greater if prevailing mortgage interest rates were higher than they are now. Low rates – 3% to 4.5% were common in 2017 – save money, and buyers interested in paying down principal quickly often can do it without breaking their bank accounts. Buyers interested in how to get the best interest rate on a mortgage should strongly consider the 15-year option.
Pros and Cons of 15-Year Fixed Mortgages
If 15-year mortgages were for everybody, the conventional 30-year mortgage would quickly vanish. That’s not happening, and affordable monthly payments are the reason.
Fifteen-year loans can save buyers a bundle on interest payments over the course of a loan, but only if they are willing to pay far more principal each month than they would with a 30-year loan. For example, a 30-year, $200,000 loan would have monthly payments of $766.95, not including taxes and insurance. A 15-year $200,000 loan would have monthly payments of $1,457.42, not including taxes and insurance.
It is possible to treat a 30-year mortgage as if it were a 15 by paying twice as much every month and having he added amount applied to reducing the principal. This would give you the flexibility to make smaller payments when money is tight and larger ones when you have extra cash.
The 30-year strategy supposes you have great financial discipline. Many people are likely to spend the money they don’t apply to their mortgage. That’s a good thing if you need the money to cover basic needs like food and clothing, but not so good if you blow it on weekend trips to Las Vegas.
For people who have a hard time managing money, a 15-year mortgage amounts to a forced savings plan. Every dollar that you apply to principal is money is money you’ll get back when you sell the house.
Lower interest rates are a factor, too. If you are committed to paying off your mortgage in 15 years or less, the lower interest charged on a 15-year loan makes it a better option. Shorter term loans are less risky for banks, so they charge less interest on them. The difference can range from a quarter to a full percentage point, which can make a substantial difference in your monthly payment.
Paying off a house in 15 years removes a huge line in your household budget. Once you are mortgage-free, your house is yours without strings, as long as you pay the property taxes and insurance. People approaching retirement often focus on paying down their mortgages for that reason alone. Money not diverted to a mortgage is money that can be used for travel, a golf-club membership or lots of fine dining.
You should also ask yourself how long you plan to keep your home, whether you can afford the larger monthly payment that comes with a 15-year loan and whether a 30-year mortgage might allow you to buy a more expensive home because the payments are smaller.
If you have a growing family and foresee a need to move to a larger home in a few years, or if you have a job that requires you to move often, there are additional factors that should be considered.
If you opt for a 15-year loan, you will build equity in your house that can be applied to a down payment on your next home. But many young families don’t have the money for a costlier 15-year loan, so the small monthly payments on a 30-year mortgage make sense.
If you’re planning to stay put in your new home, you’ll also have to wrestle with the variables. A 30-year loan might allow you to buy a more expensive home, since the monthly payments will be lower than on the equivalent 15-year mortgage.
On the other hand, paying off a loan more quickly might sway your calculations if you have children going to college. Remember, even if your kids or preschoolers today, they’ll be college age long before you finish paying off a 30-year mortgage. When they leave for school, you might be more comfortable no longer having a mortgage payment.
15-Year Mortgage vs. 30-Year Mortgage
You’ve probably heard the term house poor. In fact, you might have family members who fit the bill. People often buy houses that cost more than they can comfortably afford. If you examine their situation closely, you’ll discover the biggest problem isn’t the price of the house but the size of the mortgage payment.
The longer the mortgage repayment term and the lower the interest rate, the less a homeowner needs to send the bank each month. It’s one of the reasons 30-year mortgage caught on as the home loan of choice in the 1950s. The 30-year loan remains the gold standard in home lending, but it’s 15-year younger sibling is gaining ground.
Fifteen-year loans cost more initially, even though they often carry lower interest rates than 30-year mortgages. 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)
When is a 15-Year Mortgage Right for Me?
Fifteen years is a long time and 30 years is most of a working person’s career.
When you decide what kind of mortgage is right for you, consider what the future might hold:
- Are you in a career in which incomes increase steeply over the years, or does your field have small increases? Do you plan to change jobs often to increase your paycheck? How much more to you realistically think you might earn? If you believe your income will grow faster than your expenses, a 15-year loan might be the best option, since with each passing year your mortgage payments will be a smaller percentage of your income.
- Will you receive a sizeable inheritance during the mortgage? That could weigh in favor of either loan term. You might opt for a 15-year mortgage, applying money to your mortgage payments instead of a retirement account with the understanding that the inheritance money will go into your retirement plan. Or, you could take a 30-year loan, saving you money in the short term while allowing you to pay off most or all of the remaining mortgage with the inherited money.
- If you’re not expecting a windfall like an inheritance and you’re uncertain how much your income might grow over the years, opting for a 30-year loan makes sense. In some cases, it might be better to take the less costly long-term loan and divert the savings to a 401(k) retirement plan. Building retirement savings, like paying off a mortgage, is a long-distance run, and you should focus on both during your working years. Remember, it’s easier to access money in a retirement account than it is to extract equity from your home. Never short change your retirement savings to pay off a home loan. Only pay off the loan quickly if you have the money to spare.
- If you can easily afford the monthly payments and want to save on interest, the 15-year mortgage is the way to go. The savings can be considerable, but only if it doesn’t strain your budget. Remember, a home loan shouldn’t impoverish you. 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.
- Some people want to pay off a mortgage before their children head for college. That’s fine, since it will take a large expense out of your budget when the kids need extra money for their educations. But remember there are alternative ways to save for college, including tax-free 529 savings plans. Smaller monthly payments and a longer mortgage might be a good way to sock money away in a college account that will grow over the years.
- If you’re in your 40s or 50s and buying a new home, a 15-year mortgage could allow you to pay off your mortgage before you retire. If you think this would work for you, consult a financial planner to discuss the pros and cons. If you pay off your mortgage in 15 years, you will no longer be able to take a mortgage interest tax deduction, which might be helpful for some people in retirement. A financial adviser can help you run the numbers.
15-Year Mortgage Dos and Don’ts
Don’t take a 15-year mortgage if it will mean you can’t save for retirement. Paying off your home early could put all your money in home equity. Though it is possible to borrow against that investment with a home equity loan or line of credit, you will have to pay interest on what you borrow. Opting for a 30-year mortgage might allow you to 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 are committed to a 15-year paydown period, go for a 15-year mortgage and enjoy a lower interest rate that comes with it. If you think circumstances might change and that the larger payments that come with a 15-year loan will be a burden in the future, opt for the 30-year loan. You can always make extra payments on a 30-year mortgage, but you can’t skip payments on a 15-year loan.