Source: Flickr / Mark Moz.
When you buy a home, the less interest you have to pay on your mortgage, the more of your hard-earned money will go toward building up equity and getting your mortgage paid off. Yet, many borrowers never even consider one of the easiest ways to cut the amount you pay in interest: taking advantage of low 15-year mortgage rates. Even with the big discount that 15-year mortgage rates represent compared to their more popular 30-year counterparts, many would-be homebuyers never even consider the 15-year option. Let's take a closer look at the 15-year mortgage, and how lower rates can make a big difference in your finances.
1. Fifteen-year mortgage rates are about a percentage point lower than 30-year rates.
According to the most recent figures from Bankrate.com, a typical 30-year mortgage carries an interest rate of almost 4.25%. In comparison, the 15-year mortgage rate is around 3.25%, representing a full percentage point reduction.
Source: 401(K) 2012.
A single percentage point might not seem like a big deal. But, especially in the early years of a mortgage, the vast majority of your monthly payment goes toward paying interest, with relatively little going toward reducing principal. On a $250,000 mortgage loan, saving a percentage point in interest means about $200 per month less in interest that you're incurring month in and month out. Over time, that savings adds up, with 15-year mortgage holders paying $66,000 in total interest compared to almost three times that amount -- $193,000 -- for a 30-year mortgage.
2. A 15-year mortgage encourages financial discipline.
Fifteen-year mortgage rates are an attractive feature, but there's an obvious trade-off: you only have 15 years to pay off the mortgage. That means that, even with lower 15-year mortgage rates, your monthly payments will be substantially higher.
For instance, at current rates, a $250,000 mortgage loan for 30 years at 4.25% will carry a monthly payment of about $1,230. On the other hand, a 15-year mortgage at 3.25% for the same amount will have you paying just more than $1,755, or $525 more per month. If you're dead-set on keeping that $1,230 monthly payment, then you'll have to reduce your loan amount to $175,000.
Admittedly, coming up with $75,000 extra for a down payment -- or finding a house that costs $75,000 less -- can be a big challenge. But if you commit to reaping the benefit of low 15-year mortgage rates, then overcoming that challenge can bring huge rewards.
3. A 15-year mortgage builds home equity much faster.
Within the first year of a 30-year mortgage, you'll build up about $4,200 in home equity by paying down principal. By comparison, $13,150 of your first year's payments on a 15-year mortgage goes toward home equity -- more than triple that of a 30-year, thanks to the lower 15-year mortgage rate.
That can be useful in a number of ways. On one hand, you'll obviously have your house paid off in half the time. But it also means that you'll have more home equity to tap for a future need, whether it be home repairs or maintenance or an unrelated financial issue. With some home equity loans offering even lower rates, that can be a big cost saver, as well.
Take a closer look
For some borrowers, higher monthly payments make it impractical to take advantage of low 15-year mortgage rates. But in many cases -- especially for those refinancing existing loans that are already several years old -- considering a 15-year mortgage can make a huge difference in your overall financial picture.
