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By Jamie Smith
When you buy a home, you can finance your purchase with a 15- or 30-year mortgage. Both these options have pros and cons, and everyone's situation is unique. Here's some more information about the differences between a 15-year and a 30-year mortgage. Plus, we share the benefits and drawbacks of each option.
With a 15-year mortgage, the principal (the amount you borrow) gets repaid in 180 months. A 30-year mortgage lasts for 360 months, which allows you to pay less per month since the repayment period is doubled. While a 15-year mortgage has higher monthly payments, the shorter term means you won't have to pay as much in interest over the term of the loan. The lower payments of a 30-year mortgage are more affordable for many people, but your interest expenses over the term of the loan will be thousands of dollars higher. However, you'll have more money every month to save for emergencies, invest, and enjoy vacations and other purchases.
A 15-year mortgage has many pros and cons.
A shorter term lets you build equity in your home faster. You can own your house outright and be done with your mortgage payments sooner. This method is especially useful for people who want to retire soon. Lower monthly expenses after you’ve paid off your mortgage can make retirement much easier for many people.
A shorter mortgage term also means your house will be less likely to be underwater or upside down when you choose to sell. With an underwater or upside-down mortgage, the owner owes more than the home is currently worth.
That means even after a sale, someone underwater would still need to pay off some of the mortgage. They also wouldn't have any funds from the sale to buy another place to live. Since a 15-year mortgage gets paid down faster, the housing market won't have as much time to fluctuate before you completely own your home. Even if your house isn't worth as much as when you bought it, you'll be able to sell and get a large portion of the funds you need to buy a comparable dwelling.
Many lenders require people who pay less than 20% down for their homes to pay for private mortgage insurance (PMI). This insurance protects the bank from additional expenses if you can't make your payments on time. PMI usually costs around .5% to 2% of the loan amount per year. For those homebuyers that put less than 20% down, paying off your loan faster with a 15-year mortgage lets you build 20% of your home's value in equity faster. That way, you won't have to spend as much on PMI premiums as you would with a 30-year mortgage.
With a 15-year mortgage, your monthly payments will be higher. This plan could keep you from saving as much for things like your retirement, a new car or an unexpected medical expense. You may not have the financial flexibility you need to start a new career with a lower starting pay rate or recover from a layoff. If your income decreases and you can't make your mortgage payment on time every month, you could have to pay additional fines and fees. You could even be vulnerable to foreclosure.
Choosing a 30-year mortgage also has some pros and cons.
Making lower payments over a longer period of time can let you afford a house with amenities like more bedrooms, a big backyard, a garage, or an attic. You're also more likely to have the money you need for renovations and other expenses.
Fortunately, you can pay most mortgages off early with no penalties. Making extra payments on your mortgage lets you save money on interest and get many of the benefits of a 15-year mortgage with the added flexibility of a 30-year term. Many people send an extra payment at the end of the year or pay a larger lump sum when they get their tax refunds. Making these additional payments probably won't let you pay off your 30-year mortgage in 15 years, but you can still save on interest and shave several years off your mortgage term.
You'll pay more in interest over time with a 30-year mortgage, and you may have a higher interest rate. This interest amount makes the total costs for a 30-year mortgage thousands of dollars more than the costs for a comparable 15-year mortgage.
To understand the differences between 15-year and 30-year mortgages better, it's a good idea to crunch the numbers. Hypothetically, for a 15-year mortgage with an interest rate of 2.415% and $100,000 in principal, you would pay $662.65 (principal and interest) per month. With a 30-year loan that's also $100,000 and has a 2.887% interest rate, you would pay $415.80 per month.
With the same 15-year mortgage, you'll eventually pay $119,277 total. That's $19,277 in interest on top of the principal. If you choose the 30-year mortgage, you would pay $149,688 total. That's $30,411 more than with a 15-year mortgage. Even with the same 2.887% interest rate as a 30-year loan, a 15-year mortgage would have payments of $685.40. The total interest would go up to $23,371.76, still less than half the cost of a 30-year loan.
Choosing a mortgage term is a big decision, but it's not completely irreversible. If your circumstances change before you finish paying for your home, you can get a new mortgage with a different term. For example, someone who starts with a 30-year mortgage and gets a raise at work may want to go ahead and finish paying for their house by refinancing to a loan with a 15-year term.
You can also ask for a mortgage recast from your lender. They may be willing to recalculate your payment schedule with a shorter repayment period and let you make higher payments without refinancing. The terms of your loan will stay the same, and you can avoid any additional fees from refinancing.
If you're not sure what mortgage term to choose, you can also get a 20-year loan. Your monthly payment will be bigger than it would be with a 30-year mortgage and smaller than with a 15-year term. The interest rate is usually between the rates for the other two options as well.
To save as much as possible on interest, pick the shortest term with the highest monthly payments that you're comfortable with. To make sure you can afford the payments, some experts recommend you keep your monthly amount due to less than 28% of your monthly income before taxes and 36% of your debt. This rule of thumb can help you decide if your payments might become too much for you. If needed, you can get a 30-year mortgage and make early payments or refinance later.
If you plan to move again in less than ten years, an adjustable-rate mortgage (ARM) may be better than a fixed-rate loan. An ARM starts with a low interest rate that increases over time. If you sell your home or refinance before it increases, you can take advantage of that low initial rate.
Looking for the perfect home? Alliant has mortgage loan options to fit any budget.
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