by Maurie Backman | Feb. 5, 2021
Here's what to know about taking on a 15-year loan.
When it comes to applying for a mortgage, you have choices. Most lenders let you apply for a 30-year loan, a 20-year loan, or a 15-year loan. Some even offer additional terms, like a 25- or 10-year mortgage.
Generally, the shorter the term of your mortgage, the lower its interest rate, because lenders reward you for repaying your loan sooner. But a shorter-term mortgage also means taking on a higher monthly payment than that of a longer-term loan.
That's why 15-year mortgages aren't as popular as 30-year loans. With a 15-year loan, you pay off your balance in half the time, so while you might snag a lower interest rate, keeping up with the higher payments could be challenging.
But new data from the Urban Institute reveals that demand for the 15-year loan is increasing. In November, 17% of mortgages had a 15-year term. By contrast, only 10% of mortgages had a 15-year term a year prior.
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With a 15-year mortgage, you don't just snag a lower interest rate on your home loan. You also pay a lot less total interest over your repayment period.
Say you borrow $200,000 to buy a home and you secure a 3% interest rate for a 30-year or 15-year mortgage. To be clear, this normally doesn't happen -- you usually get a lower interest rate on a 15-year loan -- but bear with us for the sake of this example. With a 30-year mortgage, you have a monthly payment of $843.21 for principal and interest. You pay a total of $103,554.53 in interest, assuming you stick to your regular payment schedule and don't make extra payments.
Now, watch what happens when you pay that loan off in 15 years instead. Though your monthly principal and interest payment climbs to $1,381.16, you only spend $48,609.55 in interest on that loan. That's about $55,000 in interest savings -- money you can do a lot with.
Now, say you score a 2.5% interest rate on that 15-year loan (because remember, you're likely to get a lower rate for that shorter term). In that case, you're looking at about $63,600 in interest savings -- even more money to pocket over your repayment period.
If you're contemplating a 15-year mortgage, you really only have to ask two questions:
1. Can I afford it?
2. What's the opportunity cost?
If you can't swing a higher monthly payment, it's a moot point. And if you can technically cover a higher payment but it strains your budget, it's probably not worth it.
If you can easily afford to spend more each month, weigh that against your opportunity cost -- the things you give up when you put more money into your mortgage. For example, a higher monthly payment could mean lower retirement plan contributions, less money to spend on vacations, or less dining out or takeout meals. Think about whether you're willing to give those things up before you choose.
Today's low mortgage rates make a 15-year mortgage more attractive than ever. Before you assume a 30-year loan is the way to go, think about what you have to gain by paying off your mortgage in half the time. If it works for your situation, it could end up being one of the best financial decisions you make.
Chances are, interest rates won't stay put at multi-decade lows for much longer. That's why taking action today is crucial, whether you're wanting to refinance and cut your mortgage payment or you're ready to pull the trigger on a new home purchase.
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