The industry standard mortgage product in the United States is the 30-year fixed-rate mortgage, which is used by more than 85% of homebuyers. However, the 15-year fixed-rate mortgage has been gaining traction, as it can be a smart way to save thousands in interest charges over the term of your loan. Here's a comparison between the pros and cons of each loan term, so you can decide which one is best for you.
A 30-year mortgage can minimize payment and maximize your budget
The obvious reason to choose a 30-year mortgage is that it allows you to buy a home and pay less per month than you would with a 15-year mortgage. For example, based on the current average interest rates, you can expect to pay roughly $1,420 per month on a $200,000 15-year mortgage, while the payment on a 30-year loan of the same amount would be just $956.
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This can also help you maximize your homebuying budget, as lenders qualify you based on your debt as a percentage of your income. One common rule says that your mortgage payment should be no more than 28% of your gross (pre-tax) monthly income. If you earn $5,000 per month, this means that you can afford a $1,400 mortgage payment, including principal, interest, taxes, and insurance. This monthly budget will translate to the most house if you use a longer-dated mortgage.
But a 15-year mortgage can save you lots of money
The most obvious advantage of a 15-year mortgage is that you'll pay off your home in half the time it would take with a 30-year mortgage. You'll build equity faster, and be debt-free quicker than you otherwise would. However, the advantages to a 15-year mortgage don't stop there.
Despite the higher monthly payment, a 15-year mortgage has two money-saving advantages over its 30-year counterpart. First, 15-year mortgages represent a somewhat lower risk to lenders, so their interest rates tend to be lower. For example, as of this writing, a borrower with a 720 FICO score (good credit) can expect a 30-year mortgage APR of 4.10%. On the other hand, the same borrower could qualify for an APR of 3.40%. Interest rates fluctuate constantly, so check the current rates to see the difference at the time you're reading this. (Note: Click the "advanced" link in the menu to select only 30-year or 15-year mortgages.)
In addition, the mathematics of mortgage amortization work in your favor in terms of the interest you accumulate. Frankly, the details of how this works are a rather complex mathematical equation, but because of the amortization, more of your payments will start to pay down the principal right away with a 15-year mortgage.
For example, let's say that you need a $200,000 mortgage, as in our earlier example. Sure, the 30-year loan has a lower monthly payment, but just look where those payments are going, early in the loan's term.
|
Payment |
30-Year Payment |
30-Year Interest |
Interest (as % of payment) |
15-Year Payment |
15-Year Interest |
Interest (as % of payment) |
|---|---|---|---|---|---|---|
|
1 |
$956 |
$668.33 |
69.9% |
$1,420 |
$566.67 |
39.9% |
|
2 |
$956 |
$667.37 |
69.8% |
$1,420 |
$564.25 |
39.7% |
|
3 |
$956 |
$666.41 |
69.7% |
$1,420 |
$561.82 |
39.6% |
The savings can be massive
Because you'll be paying a 30-year mortgage for twice as long as a 15-year mortgage, you might expect that you'll pay twice as much interest over the term of the loan. Sounds reasonable, right?
However, the reality is that the 30-year mortgage is even more expensive than that. In our example of a $200,000 mortgage, your $956 monthly payments on the 30-year mortgage add up to $344,160, which means that you'll be paying a total of $144,160 in interest.
With the 15-year version, your $1,420 monthly payments total $255,600, which means you're only paying $55,600 in interest -- a full 61% less than the 30-year mortgage.
Here's a mortgage calculator that can help you estimate how much house you could afford with the two different mortgage terms.
Which is best for you?
It depends. In the interest of full disclosure and to give a personal example, I've bought three homes in my lifetime. Two of them (including the one I currently live in) were purchased with 30-year fixed-rate mortgages, and the other was purchased with a 15-year, so I've taken advantage of the benefits of both under different circumstances. The home purchased with a 15-year mortgage was my "starter home," and I bought a relatively inexpensive house in order to be able to put 20% down and avoid PMI. My current home is larger and was in a considerably higher price range, so a 30-year mortgage keeps my payment affordable, giving me more financial flexibility to invest and avoid credit card and other higher-interest debts.
As I mentioned, the 30-year fixed-rate mortgage is the industry standard in the United States, and is chosen by the vast majority of homebuyers. However, if you can afford a higher monthly payment, or are planning to buy a home well within your maximum budget, a 15-year mortgage and the savings potential it offers is definitely worth a look.
