by Dan Caplinger | Dec. 23, 2019
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Among homebuyers, the 30-year mortgage is by far the most popular option. Even with interest rates at extremely low levels, 30-year mortgages routinely make up more than 80% of all home loans.
Yet there are alternatives to the 30-year mortgage that can make more sense for homeowners. In particular, the 15-year fixed mortgage has many of the same favorable traits as its 30-year counterpart, but there are also some advantages from going with the shorter term. Below, we'll look more closely at three reasons why you should consider a 15-year mortgage.
You could routinely get significantly lower interest rates if you borrow using a 15-year mortgage as opposed to going with a 30-year. Current 30-year mortgage rates are around 4.5%, according to the latest information from the Freddie Mac Primary Mortgage Market Survey, but you can get a 15-year loan for below 4%.
That half percentage point might not sound like a lot, but over time, it can add up. For a home loan of $300,000, half a percentage point works out to about $125 in monthly interest savings at the beginning of the loan period. Over the long run, you'll pay less than $100,000 in total interest on that 15-year mortgage, compared to almost $250,000 on a 30-year mortgage at current rates.
The reason why so few people pick 15-year mortgages is that even with lower rates, monthly payments are higher. That's the trade-off you have to make in order to get your mortgage paid off twice as quickly. The advantage is that even early in the mortgage, you'll build up home equity a lot faster with the 15-year mortgage than with its 30-year counterpart.
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Continuing to use the example of a $300,000 mortgage, if you borrow using a 30-year mortgage at 4.5%, your monthly payment will be $1,520. A similar 15-year mortgage at 4% will have a $2,220 monthly payment. Many people just can't afford that extra $700.
Those who can afford higher payments will see a quick reward. In the first year of the 15-year mortgage, you pay down $14,900 of your outstanding loan amount. That's more than triple what 30-year mortgage borrowers will pay down, building up home equity of just $4,840 over the same time period.
Having more home equity is helpful not just because you pay the loan down faster but also because tapping it through a home equity loan or line of credit can be more helpful. That can give you more financial flexibility, and although interest on home equity loans is no longer tax-deductible for most purposes, it's still a good alternative to higher-rate forms of debt.
Lastly, committing to a 15-year mortgage ensures that you won't stretch to buy an overpriced home. During the housing boom, many mortgage borrowers ended up having to default on their loans because they couldn't afford monthly payments. Some mortgage types were even riskier than standard fixed 30-year mortgages, with resetting interest rates proving catastrophic for hard-hit homeowners without the ability to pay more.
For instance, in the above example, if you had only $1,520 per month to spend on a mortgage payment, you'd only be able to borrow about $205,000 using a 15-year mortgage. You'd therefore either have to buy a less expensive home or find $95,000 as a down payment to get the loan. Many high-demand real estate markets don't make that a good option, especially for most homeowners who struggle to make payments. Nevertheless, if you can commit to a 15-year mortgage, you'll be a lot more financially secure throughout the homebuying process.
There are many homebuyers who won't be able to get the homes they want if they can't have the lower payments that a 30-year mortgage provides. But if you have some wiggle room and want to enjoy the interest savings and faster home equity buildup that a 15-year mortgage provides, it's definitely worth a closer look.
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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