Read this before you decide on a mortgage term so you don't end up wishing you'd made a different choice.
When you borrow to buy a home, you have many important decisions to make. One choice relates to your repayment timeline. Specifically, you have to decide how long your loan term should be.
Many borrowers opt for a 30-year loan, but you can also choose to borrow for less time. In fact, a 15-year loan, which tends to come with a lower interest rate, is a popular option. A 15-year mortgage also provides considerable interest savings over the life of the loan. This is because you're paying interest for half the time compared with a 30-year loan.
The low interest rate and substantial interest savings can make a 15-year loan seem very attractive. Unfortunately, there are three big reasons you may come to regret your decision if you opt for this type of mortgage. Here's what they are.
1. Your monthly payments will be high
It may seem obvious, but when you choose a 15-year repayment term over a 30-year loan, you have just 15 years to pay back the entire amount. You'll make a whopping 180 fewer payments than with the 30-year loan. As a result, each payment has to be much bigger to fully repay your balance.
How much bigger? Here's an example.
- Let's say you qualified for a 30-year fixed-rate loan at 3.00% interest. For each $100,000 in mortgage debt you took on, you'd be looking at a monthly payment of $422 in principal and interest.
- If you opted for a 15-year loan, even at a much lower rate of 2.30%, you'd be looking at a payment of $657 per $100,000 in mortgage debt. That's $235 extra per month for each $100,000 borrowed.
Of course, your total interest costs are lower with the 15-year loan option. You'd pay just $18,335 in interest per $100,000 borrowed over the life of the loan, compared with $51,777 for the 30-year alternative.
But the extra money you'd have to pay each month could put you in a financial squeeze -- especially if you're on a tight budget. And if you have a larger mortgage payment, you'll need a bigger emergency fund, and it will be more difficult to make the payments if you experience a layoff or income reduction.
2. You'll have less flexibility in which financial goals to prioritize
When you choose a 15-year loan, you must pay off your mortgage in half the time compared with the 30-year loan. You can't just reduce your payments if you decide it's an especially good time to invest in the stock market or you want to save for important home repairs.
If you opt for the 30-year loan, though, there's nothing stopping you from paying extra on your home -- if you want to. But you also aren't required to do so.
In some months, you could decide to make a larger payment to get clear of your mortgage debt early. But during other times, a different financial goal could take priority. You're less likely to have this flexibility when you've committed to a 15-year loan.
3. You'll lose your mortgage interest deduction in half the time
The mortgage interest deduction can defray the cost of borrowing if you itemize your taxes each year. This deduction is a valuable tax break that allows the government to subsidize your mortgage.
If you pay off your mortgage ahead of schedule, you'll miss out on those tax savings. Of course, it's true that your interest costs exceed the amount of your tax break. But for most people, mortgage interest is one of the few or only types of debt with deductible interest. It makes little sense to devote extra money to deductible debt when you could instead use that cash to reduce or avoid other loans (such as car loans) that don't provide tax breaks.
Ultimately, you'll need to think carefully about your financial goals and the opportunity cost of a 15-year mortgage when you decide what's best for you. But keep in mind, the low interest rate and interest savings that come with a shorter loan term definitely also come with drawbacks that you'll need to consider when making your decision.
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