A 30-year fixed mortgage is the gold standard for home loans and has been for a long time.
In July 2017, 87.3% of home loans were 30-year fixed mortgages, according to the Mortgage Bankers Association’s monthly report. These loans are popular with borrowers because the extended repayment time allows for more affordable monthly payments.
What is a 30-year fixed mortgage?
“30-year fixed” refers to the loan term and the fact that the payments are the same every month for the 30 years it will take to pay off the loan. That is with interest included. The “fixed” applies there, too. The interest rate on this type of mortgage is fixed over the life of the loan. So, the rate you sign up for is the rate you pay every year for 30 years.
The average rate for a 30-year fixed mortgage in 2017 was 3.78% according to Freddie Mac, a federal home loan mortgage corporation. That interest rate can vary slightly between lenders, but the rate you receive depends on several factors, some you can control, some you cannot. The most well-known factor is your credit score, and that you can control.
|Credit Score||Interest Rate|
*credit myFICO (September 19, 2017)
As the chart above shows, the most affordable rates go to those with a credit score of 680 and above, with the best rates reserved for scores 760 and above. That isn’t to say you won’t be approved for a mortgage with a lower credit score, you’ll just pay more to borrow that money.
In fact, credit scores are not the biggest factor in determining whether banks approve a mortgage. A survey by The Fair Isaac Corporation (FICO) says that poor debt-to-income ratio (DTI) is the No. 1 reason mortgage applications are denied. Lenders want the ratio to be under 30%.
It’s a Good Time to Get a Mortgage
Fixed rate mortgages are attractive because it’s comfortable to lock in a low monthly payment for a long period of time. If you wait two or three years or even two or three months, interest rates might move up, and your payments would increase.
Historically, rates are good right now, and when compared to 30 years ago, rates are exceptional. The 30-year fixed mortgage rate peaked at an astounding 18.63% in 1981 and was as high as 8.64% in the year 2000.
When the Fed raises the rates it charges banks, you might expect mortgage rates to go up as well, but that isn’t always the case. Financial experts have expected to see mortgage rates on the rise for years now, and it just hasn’t happened.
When you look back over the course of history, mortgage rates exploded in the 1970s, 80s and 90s. The low, very affordable numbers prevalent now are a return normal. So, while there is no reason to run out the door trying to get approved for a mortgage, if you are in the market for a home, it’s a good time to buy something affordable.
Pros and Cons of the 30-year fixed mortgage
- Low monthly payments
- Flexibility with payments
- Predictable payments each month
- Low rates are locked in for 30 years
- Tax deduction for mortgage interest
The biggest advantage of a 30-year fixed loan is the low monthly payments. There’s a lot that goes into buying a home. A mortgage payment is a combination of principal (value of the home) and interest, as well as, homeowner’s insurance and real estate taxes. That can be a lot to handle on a month-to-month basis. The 30-year term helps borrowers afford more house than they would otherwise be able to buy.
The low payments also offer some flexibility to homeowners when their income rises. They can choose to pay more than their scheduled monthly payment, directing the additional payment toward the principal. Lowering the principal will save money that would have compiled interest. There is no penalty for paying more per month, and choosing to do so will help pay off the loan faster (in less years).
In other words, you can turn a 30-year mortgage into a 15-year mortgage simply by adding a few hundred dollars to monthly payments. That will save you a lot of money over the life of the loan.
- Higher interest rate than 15-year loans
- Far more expensive over the life of the loan
- The debt hangs around longer
- Not ideal for borrowers on the move
The primary disadvantage of a 30-year mortgage is the interest rate is higher. That’s the price you pay for having extra time to pay off the loan, and the cost can be fairly steep. Not only is the interest rate higher, but it accumulates for twice the amount of time, when compared to a 15-year loan. The combination of the two factors means a 30-year mortgage more than doubles the cost of interest compared to a 15-year mortgage. For a 4% interest rate, a 30-year fixed loan will accumulate 2.2 times as much interest as a 15-year fixed loan.
The longer the debt is on your books, the more limited you’ll be financially, and a 30-year fixed loan is not a great option if you plan on moving around. A better loan would be a 3-year or 7-year ARM, which has a variable interest rate with a lower introductory rate. Ideally, you would have sold the house by the time the variable rate rises past the alternative fixed rate.
Differences between a 30-year fixed and 15-year fixed mortgage
|30-year fixed||15-year fixed||15-year fixed|
|Total Interest Paid||$107,736||$39,997||$29.998|
(Mortgages include 1.25% property tax and $1,000/year homeowner’s insurance)
Take a look at the chart and one number should jump out at you: Total interest paid on a 30-year fixed mortgage is a lot.
By the end of the 30-year fixed loan, you’ll end up paying nearly 2.5 times what the original loan amount was and almost double the value of the home. By comparison, you’ll spend $120,000 more over 30 years than you would for a 15-year fixed loan.
What it really boils down to are the monthly payments. An extra $400 per month is a lot to swallow for a 15-year mortgage. You certainly don’t want to overextend yourself with a 15-year mortgage and struggle to make payments.
When comparing mortgage loans, you are really comparing houses. If you can afford the monthly payment for a $200,000 house on a 30-year fixed mortgage, you can also afford the monthly payment on a $150,000 house on a 15-year fixed mortgage. The homes have similar monthly payments. The difference is the price of the house: $200,000 for the 30-year and $150,000 for the 15-year.
Now, take a look at the savings. Assuming you make the standard 20% down payment, the 15-year $120,000 loan will save you over $77k in interest and nearly $180k overall.
Comparing Mortgage Terms (i.e. 15, 20, 30 year)
Dos and Don’ts When Looking for a Mortgage
- Start by calculating how much you can afford each month.
- Consider how long you plan to stay in the house. You might have a job that requires you to move frequently.
- Do you plan to start a family? You should anticipate how much space you’ll need.
- Is the house near good schools?
- Can you reasonably expect the house to improve in value?
- Don’t borrow your limit on a 30-year mortgage. You might love the backyard or the walk-in closet, but that money could be used elsewhere. You’ll need to build an emergency fund should something bad happen. If the refrigerator breaks or you need to repair the roof, you need to have cash on hand to handle these kinds of problems. You should also have money to set aside for retirement savings.
- Don’t put less than 20% down. Otherwise, you’ll need private mortgage insurance (PMI) to protect the lender in a foreclosure. Plus, a 20% down payment keeps your monthly payments affordable.
The word mortgage literally translates to “death pledge”. Seems like a rather ominous word to associate with something you’ll “live” in, but no, that isn’t referring to mortgages as a suicide mission.
It actually means the pledge dies when you fulfill your obligation. A 30-year fixed mortgage is an awfully slow kill, but in the end, you’ll have a happy place to call your own.