The low payments on a 30-year mortgage are certainly attractive to homebuyers, as they let you afford the most "house" your budget allows. However, not only are 15-year mortgage rates lower, but there are some other compelling reasons to consider the shorter option. In fact, the faster equity and interest rate savings are such great benefits that it makes me wonder why the 30-year option is so much more popular.
Lower rates, but not as popular
Despite having lower interest rates, 15-year mortgages are still not very popular in the United States. In fact, about 85% of new home loans carry 30-year terms. People like 30-year mortgages because they allow the loan to be stretched out over a longer period of time. This means the monthly payments are lower and lenders will allow the borrower to buy a more expensive house.
A lot of people make the mistake of taking out a 30-year mortgage, planning to pay it back early if the budget allows. However, you'll still end up paying more money to the bank. According to Bankrate.com, there is currently a 1% gap between 30-year and 15-year mortgage rates, which are 4.27% and 3.27% respectively. So even if you pay back a 30-year mortgage in just 15 years, you'll have been paying a considerably higher interest rate along the way.
You'll own more of your house faster
With a 15-year mortgage, you'll start building equity in your home much faster.
With the current rates, less than 28% of your first payment on a 30-year mortgage goes toward the principal. Meanwhile, a full 61% of your 15-year mortgage payment goes toward paying off the principal right away, and the payment itself is higher due to the shorter loan duration. Effectively, you start paying down the principal more than three times faster with a 15-year mortgage.
For example, let's say you obtain a $250,000 mortgage to buy your house. If you choose the 30-year option, after one year you'll still owe $245,800, meaning you've paid down $4,200 of the principal amount. With a 15-year loan, you'll owe $236,870, so you'll have paid down over $8,900 more after just one year.
And, as time goes on, the increased equity becomes an even bigger selling point. After five years of paying the 15-year mortgage, you'll have paid down more than $70,000 of the principal, compared with just $22,900 if you chose a 30-year mortgage.
Save huge sums in the end
Perhaps the most compelling argument for using a 15-year mortgage is the total cost of the loan. With a $250,000 mortgage, your monthly payment would be $1,233 for a 30-year term or $1,759 for a 15-year term.
Even though the 30-year option is cheaper on a monthly basis, stop and consider how much you'll pay over the life of the loan. The 360 payments on a 30-year mortgage will add up to almost $444,000, or nearly $194,000 in interest alone.
On a 15-year mortgage, the payments total under $317,000, or less than $67,000 in interest. So, by choosing a 15-year mortgage option, you can literally save six figures when all is said and done.
Think about how much house you can "afford"
The combination of lower 15 year-mortgage rates and the time advantage that comes with them makes a 15-year loan the best option for your long-term financial health. You'll pay down your debt much faster, own more of the house in less time, and save a bundle on interest. Next time you decide to buy a home, ask your banker or mortgage broker what you could afford with a 15-year mortgage. It might surprise you how much you can buy -- and pay off twice as quickly.
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