An Easy Way To Save 30% On Your Next Home

Source: Flickr / American Advisors Group.

One of the biggest decisions you'll make in the home-buying process is what type of mortgage to get. Unfortunately, many people simply choose a 30-year fixed rate loan because it's the most popular. However, even though the payment will be higher, a 15-year mortgage can be the wisest financial decision you can make when buying your house. Here are a few reasons why the shorter loan option might be right for you.

You'll own your home twice as fast
Okay, this is the obvious benefit of a 15-year loan, but couldn't the same effect be achieved by simply paying more on a 30-year loan each month? Sure it could! I have a lot of friends who get 30-year loans and "plan on paying extra."

However, you're forgetting about the significant difference in interest rates between the two. Currently a 30-year loan comes with an interest rate of about 4.3%, as opposed to just 3.3% for a 15 year mortgage.

Consider the example of a $200,000 loan. If you were to get a 30-year loan and plan on paying it off in half the time, you would need to pay $1,515 per month for the 15-year period in order to get the balance to zero, which includes the $989 standard payment and an extra $526 each month toward the principal. The payment on a 15-year mortgage with the same balance would be $1410 and pays off the house just as fast, thanks to the lower interest rate. This may not seem like a huge difference, but keep in mind that this means you would save almost $19,000 over 15 years.

Another reason to just get the shorter loan from the start is it makes your early payoff automatic. How many times have you told yourself you'd save a certain amount of money and fell short? The same thing happens all the time with people who plan on paying extra every month.

You give away more money with a 30-year loan
Even though the difference between interest rates on a 15- and 30-year loan may not sound like much (just a percentage point or so), the time difference is what really matters to your bottom line. The combination of the higher rate and the 15 extra years will cost over $100,000 more in interest alone.

Check out the total cost over the life of each type of loan, and decide if paying $420 less per month for a 30-year loan is worth paying nearly three times the interest!

Build your equity faster
Even though you pay a little more each month, you'll build equity in your home more than twice as fast with a 15-year loan than you would with a 30-year. Consider that from the start, much more of your payments go toward paying down your principal. Of your first payment on a $200,000 30-year mortgage, only about $273 goes toward the principal and $717, or about 72% of the payment goes toward interest.

On a 15-year loan, you start significantly paying down your principal right away. A full $860, or 61% of your very first payment goes toward the principal. After five years, 72% of the 15-year mortgage's payment goes toward the principal, as compared to just 34% of the payment of a 30-year mortgage.

A little more now for a lot more later
The bottom line here is to really think about what you're doing when applying for a mortgage. Consider whether you can afford a little bit more each month, and if you can swing it, a 15-year mortgage will do wonders for your financial situation years down the road.

You have two choices here. Either you'll own your house free and clear in 15 years, or still owe more than 65% of the original balance of your loan. It's up to you!

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Matthew Frankel

Matt brought his love of teaching and investing to the Fool in order to help people invest better, after several years as a math teacher. 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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