If you're buying a home, you're likely acquiring not only a beautiful new house, but also a big fat loan to go with it. Mortgages are the biggest liability on most homeowners' balance sheets, and if you're not careful, this liability could become a burden that interferes with other important financial goals.
Picking mortgage terms that make sense for you is essential to avoiding financial disaster. You'll generally want to look for a fixed-rate mortgage with the best rate you can find, an affordable monthly payment, and a reasonable repayment period.
The big question is: What exactly is a reasonable repayment period? Many homeowners take 30-year loans, but you shouldn't assume that's the best choice for you. There's also a 15-year loan option to consider. Both a 15-year mortgage and a 30-year mortgage have pros and cons, so check out these tips to help you decide which one you should choose.
Image source: Getty Images.
Payoff time
It may seem obvious, but the biggest benefit of a 15-year mortgage is that you'll pay the loan off sooner. Being mortgage-free will give you peace of mind and a lot more flexibility to accomplish other financial goals -- and a 15-year mortgage gets you there in half the time.
Paying your mortgage off in just 15 years means you're much more likely to be done with repayments before you have to start sending tuition checks to your kids' colleges -- and before you retire and start living on a fixed income.
Unfortunately, because people are buying houses later, it's becoming more common for Americans to carry mortgages into retirement. Close to half of baby boomers are still paying off mortgages, and they owe a median amount of $90,000. This is unfortunate because a big mortgage bill can seriously put a crimp on your plans to travel or kick back with the grandkids in your golden years.
If you want to enjoy life with no house payment while your fellow retirees are still sending in their monthly mortgage checks, then a 15-year mortgage may be a better bet.
Total costs of a 15-year vs. 30-year mortgage
A 15-year mortgage is going to be a lot cheaper in the long-run. Reduced costs and lower risk for lenders means rates for a 15-year loan are substantially lower than rates for a 30-year mortgage. Plus, since you're paying off the loan in half the time, you won't pay interest for as long.
National average mortgage rates reported by Zillow.com as of March 10, 2017 were 4.07% for a 30-year fixed-rate mortgage and 3.24% for a 15-year fixed-rate mortgage. This table shows the difference in total costs for various mortgage amounts based on these rates:
| Mortgage Amount | Total Amount Paid | |
|---|---|---|
| 15-Year Mortgage | 30-Year Mortgage | |
| $100,000 | $126,393 | $173,325 |
| $200,000 | $252,786 | $346,651 |
| $300,000 | $379,179 | $519,976 |
| $400,000 | $505,572 | $693,302 |
Monthly payments of a 15-year vs. 30-year mortgage
While the total costs of a 15-year mortgage may be hundreds of thousands less than those of a 30-year loan, the monthly payments can be much higher, because you'll be paying the loan off on an accelerated schedule.
Using Zillow's interest rates, consider the monthly payments on a 15-year and 30-year mortgage loan of varying amounts
| Mortgage Amount | Monthly Payment | |
|---|---|---|
| 15-Year Mortgage | 30-Year Mortgage | |
| $100,000 | $702 | $481 |
| $200,000 | $1,404 | $963 |
| $300,000 | $2,107 | $1,444 |
| $400,000 | $2,809 | $1,926 |
Those higher monthly payments do come at a cost. You may have to buy a smaller house if you cannot afford the larger payments. Plus, if you are paying more money toward your mortgage, you have less to invest. Since mortgage rates are often lower than the return you can get from investing, there is an opportunity cost to spending extra money to service your debt.
If you took out a $200,000 loan over 30 years instead of 15, you'd have an extra $441 a month in spare cash to invest -- a little more than $5,000 per year. If you put $5,000 annually into an IRA, even assuming a conservative rate of return of just 5%, you'd have an account worth around $350,000 at the end of 30 years.
Do the math: Your $350,000 investment balance minus the $93,856 in extra interest you paid on your 30-year mortgage means you'd have $256,166 more money than'd have if you'd paid that extra $441 in higher monthly mortgage payments to get the 15-year loan.
Flexibility of a 15-year vs. 30-year mortgage
While the biggest upside to a 15-year mortgage is the fact your home is paid off early, the biggest benefit of a 30-year mortgage is flexibility. You can choose to pay your mortgage off early if you want, or you can opt to invest instead. Lower required monthly payments mean you aren't locked in to paying so much to a mortgage lender, so it will also be easier to make payments in times of financial hardship.
If you have a tendency to spend instead of save extra cash, taking a 15-year mortgage can sometimes be the better choice because higher house payments ensure that more of your income goes toward a tangible asset that usually appreciates in value.
However, if a 15-year mortgage would consume all your extra cash and leave you unable to save for important financial goals like retirement, then the 30-year loan will always be a better option. A home isn't an asset you can sell easily in an emergency, and it won't give you income as a senior, so you cannot compromise other financial priorities just to pay off your home sooner.
Even if you have cash to pay higher mortgage payments without abandoning other financial needs, a 15-year loan still isn't always best. If you're disciplined enough to use extra funds to pay down your mortgage or invest, a 30-year mortgage may be the smarter choice.
