A 15 vs. 30 year mortgage–what’s the best option? It’s a question everybody who buys a home must answer. Here we provide the pros and cons of both mortgage types.
I’ve had mortgages on the brain recently. When assembling our mortgage history, I was struck by the decisions we face along the way. Aside from deciding when to refinance, the biggest decision we faced was what type of mortgage to get.
While we could’ve (arguably) saved some money by opting for adjustable rate mortgages, we already have enough unknowns in our life. Thus, we quickly narrowed our options to fixed rate products. While there are some 20 (and even 40!) year fixed rate mortgages out there, 15 and 30-year mortgages are far more common.
So… Which to choose?
Advantages of a 15-year mortgage
The higher payment on a 15-year mortgage might look scary at first. But it’s actually got some major advantages.
For one, a shorter mortgage is amortized over half the total time of a 30-year option. A bigger chunk of that larger payment goes to pay down principal each month. That means that even if you’re paying the exact same interest rate, you’ll pay much less interest on a 15-year mortgage.
But here’s the thing: you likely won’t pay the same interest rate. In fact, mortgage rates are usually significantly lower for 15-year vs. 30-year mortgages, all other things being equal. Combine that with the shorter amortization term, and you could save hundreds of thousands on interest.
Plus, since you’re paying more towards principal each month, you’re building up equity faster. This is great for your net worth, of course. But if you have to pay private mortgage insurance until you have 20% equity in your home, it’s even better. You’ll hit the 20% mark faster so that you can remove PMI payments from your mortgage check.
Advantages of a 30-year mortgage
That breakdown makes 15-year mortgages sound like the way to go. But 30-year mortgages also have some advantages.
The main advantage in a 30-year mortgage is the lower payment. Even with a higher interest rate, your monthly payment is likely to be lower with a 30-year mortgage. Sometimes it could be hundreds of dollars per month lower.
If you’re just on the brink of being able to afford homeownership over a rental, a 30-year mortgage may be your best option. Getting into a home with a longer term mortgage at least gets you started building up equity in your home. And you can always refinance to a 15-year mortgage later on, should you choose to do so.
But here’s the deal: those smaller payments on a 30-year mortgage will largely go towards interest for the first several years of the loan. It will take much longer to build up equity in your home.
15- vs. 30-year mortgages by the numbers
One place to look when making this decision is at the hard numbers. Let’s look at a scenario to get you started:
With your credit score of 700-719, you get some great mortgage rates. You’re shopping for a mortgage of $200,000, and you have a 20% down payment saved.
Note: If you don’t know your credit score, here are several free ways to get it.
Let’s say your interest rate on a 30-year mortgage would be 3.7%. On a 15-year mortgage, you’d qualify for 3.1%. Not a big difference, right? Well, look at the math, first.
We’ll use this mortgage calculator.
- Monthly Payment: $1,390.80
- Total Mortgage Cost: $250,344.45
- Total Interest: $50,344.45
- Monthly Payment: $920.57
- Total Mortgage Cost: $331,403.75
- Total Interest: $131,403.75
In short, if you pay no extra payments on your mortgage, a 15-year mortgage could save you $81,059.30 over the life of your loan!
That’s a lot of money. But don’t apply for that 15-year mortgage just yet.
The best of both worlds
What if you’ve decided that you want to be mortgage-free as soon as possible? A 15-year mortgage is a no-brainer, right? Maybe, but maybe not.
Depending on a number of factors, such as your income, job stability, and level of self-discipline, you might be better off taking out a 30-year mortgage and then simply over-paying it every month.
The advantage of this approach is that you get the best of both worlds. You can pay your mortgage off in 15 years (give or take) while still having the flexibility to fall back to the lower payment level if you ever run into financial problems.
Another look at the numbers
Let’s say you take out the 30-year mortgage but decide to make the 15-year mortgage payment every month. So you’ll add about $470 per month to your mortgage payment.
In this case, you’d pay off the mortgage in 15 years and 11 months, and you’d pay a total of $64,701.42 in interest. That’s a $66,700 savings above what you would have originally paid in interest on the 30-year mortgage.
You’ll still pay more in interest with this plan than with the 15-year mortgage, of course. You’re paying a higher interest rate. But here’s the thing: while you’re paying off your mortgage more quickly, you’ll have tons of flexibility.
Maybe you’re purchasing a home that needs some updates. So you make the minimum mortgage payments for a year and put that extra $470 towards home improvements. Then you kick that money into your mortgage for the next decade or so. You’ll still pay off your mortgage early and save, but you’ll also cash flow home improvements.
Also, if you happen to lose your job or run into other financial difficulties, you can easily free up nearly $500 per month from your budget without risking losing your home.
Alternatively, since mortgage interest rates are so low right now, you might decide not to pay off your mortgage early. Instead, you take that $470 per month and invest it. If you earn an average 7% return, you could easily out-earn the extra interest you’ll pay on your home!
So which is best for you?
Honestly, it depends. Here are a few ways to think about your goals and how to reach them:
Goal: Become mortgage-free
- If you’re very motivated and self-disciplined, the 30-year mortgage could work well for you. You’ll just make the extra payments, but have some flexibility if you need it.
- What if you tend to spend all the money you have available? In this case, a 15-year mortgage forces you to pay off your home more quickly.
Goal: Buy your first home
- If you don’t have a lot of wiggle room in your budget, a 30-year mortgage can get you into your first home more quickly. You can buy an affordable home, build up equity, and then try a 15-year mortgage when you refinance or buy your next home.
- What if you have enough room in your budget for a 15-year mortgage? In this case, you’ll build up equity much more quickly, which can help you move up in homes sooner if that’s your goal.
Goal: Invest as much as possible
- If your goal is to invest as much as you can and you think you can beat your mortgage’s interest rate, opt for the smaller payment on the 30-year mortgage. Then, invest the difference in the payments. With today’s low mortgage rates, you could come out well ahead.
- But if you’d rather become as debt-free as possible before you start investing heavily, the 15-year mortgage helps you do that faster.
The best place to begin here is with a clear understanding of your personal mortgage goals. Then, run the numbers for your particular situation to see which option works best for you.