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# 15-Year Mortgage Rates Are Even Better Than They Appear

Average 15-year mortgage rates in the U.S. are often about a full percentage point less than the average 30-year rate. Currently, the 15-year rate is 3.25%, quite a bit lower than the 4.21% average for a 30-year mortgage. Now, this rate difference wouldn't make a ton of difference if we were comparing the same type of loan. For example, the difference between rates of 3.25% and 4.21% on a \$200,000 15-year mortgage payment is less than \$100 per month.

However, the real benefit of a 15-year mortgage is not only the lower rate, but the shorter time frame during which your interest is compounded. The amount of interest you pay over the life of the loan is drastically reduced thanks to this double benefit. A 30-year mortgage may tempt you, due to the lower monthly payment, to buy a bigger house; but as far as your financial future is concerned, I think the numbers speak for themselves.

Mortgage interest is more than just a percentage
More of a factor than the lower interest rate is the length of time during which the interest is calculated. When calculating a mortgage payment, banks use a somewhat complex formula that depends exponentially on the length of the loan.

In other words, a loan that's twice as long will cost more than twice as much in interest. With a shorter loan term, more of the monthly payment immediately goes toward paying down principal, which has a big effect on the total cost of the loan.

While the formula itself isn't necessary for you to know, as a homebuyer, the implications of the formula are important to understand. Let's consider an example.

Let's say that you want to borrow \$250,000, and you want to compare your 15- and 30-year loan options. At current rates, your monthly payment would be just \$1,224 with a 30-year loan as opposed to \$1,757 per month on a 15-year loan. The 30-year option sounds pretty good, right?

Well, over the course of the 30-year mortgage, you'll end up paying \$190,641 in interest, while the total interest on the 15-year mortgage will only add up to \$66,201. So, the cost of borrowing the \$250,000 over 15 years is 65% cheaper than borrowing over 30 years.

Build equity faster
By taking on the larger payment, you can build equity in your home much faster. Going back to our earlier example, let's say the home's value is \$312,500 when you made the purchase. This would make a \$250,000 mortgage exactly 80% of the home's value, a pretty standard amount.

Let's assume that the home appreciates in value by 4% per year on average, which is very reasonable by historical standards. Take a look at how much more quickly you could build equity in your home with a 15-year mortgage.

A winning deal
In a nutshell, a 15-year mortgage is simply the better value, and it is definitely worth considering searching for homes that you can afford with a 15-year mortgage. You'll pay about 40% more per month to pay off the home twice as fast.

The 15-year mortgage rates are much more attractive than 30-year rates, and the shorter time frame means you'll pay much less interest and build equity in your home faster. Even though the payment is a bit higher, it is, by far, the cheaper way to buy a home.

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• ###### Report this Comment On June 18, 2014, at 3:46 PM, toph36 wrote:

Clearly a 15-year is a better option, if you can afford it. I am buying a new house. The difference in monthly payments between a 15-year and 30-year is \$700. If I could make that extra payment plus save for retirement, I would do both. For me, I need to save that \$700 a month for retirement. Over the next 15-years, I should be able to make up the difference and then some. Plus, don't forget that the interest is tax deductible, so account for 25-28% of the interest payment tax savings (assuming that deduction doesn't get cut).

• ###### Report this Comment On June 18, 2014, at 4:13 PM, leradron wrote:

It's only deductible to the extent it exceeds your standard deduction. Also, there are income phaseouts on itemized deductions starting in 2013. 25-28% is very, very generous.

• ###### Report this Comment On June 18, 2014, at 7:42 PM, anash91 wrote:

30 year makes more sense if you get an annual compounding on that money invested greater than that of your interest rate on the loan. Just paying of the house sooner doesn't always make financial sense, but it makes psychological sense.

• ###### Report this Comment On June 19, 2014, at 4:14 AM, scubadver wrote:

The 15 isn't always the better option as it neglects to include opportunity cost. If the assumption is made that the maximum payment affordable is the 15, then the difference between monthly payments should be considered as invested. If invested and you can generate an average return in excess of 5.8% then the 30 year is a better option.

Considering home equity should only be the consideration of someone who is intending on selling within the term of the mortgage.

In addition, depending on your financial situation, accelerating payments on a 30 year may make the numbers work better for you as well and decrease your overall interest payment.

The individual should determine their own goals, and then run the numbers to determine what is the best option for them.

Things are never quite simple with long term major investment decisions.

• ###### Report this Comment On June 19, 2014, at 7:45 AM, SCStockPicks wrote:

As scubadiver said, situations depend on the individual. In general, I recommend to my clients they get a house they can pay at a 15 year rate, but I don't always recommend the 15 year mortgage.

This is particularly true for dual-income families. By taking getting a 30 year mortgage but paying at the 15, it allows them to back off should one of the two incomes cease, so a job crisis doesn't become a house crisis. There are also some cases, particularly with younger clients, where I recommend a 30 year and investing the difference. Both these solutions require self discipline on the part of the client and that is emphasized.

• ###### Report this Comment On June 19, 2014, at 10:21 AM, damilkman wrote:

For most people looking to purchase a home the lowest possible payment is preferred. Usually even starter homes are on the edge of being affordable. I could not even do a 30 year for my first home. I had to use a five year balloon. So did most of my friends.

• ###### Report this Comment On June 20, 2014, at 12:58 PM, Rafauku wrote:

I agree with anash and since the rates are so low it is hard to make the case for putting money into something that will only appreciate 4% on average. With the ability to continue compounding your money in a brokerage account folks would be much better served going that route while still benefiting from the tax breaks that a mortgage provides. Naturally this requires discipline and ability to put away those additional funds but will end up the much wiser decision.

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Matthew Frankel
KWMatt82

After several years as a high school math teacher, Matt brought his love of teaching and investing to the Fool to help people invest better. Matt specializes in writing about the best opportunities in bank stocks, real estate, and personal finance, but loves any investment at the right price. Follow me on Twitter to keep up with all of the best financial coverage!

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