Most homebuyers finance their purchases with a 30-year term fixed-rate mortgage rather than an adjustable-rate mortgage, but, in some cases, a 15-year term might be a better choice.
Let’s look at the differences between a 30-year mortgage and a 15-year mortgage and see which one might be the best for you.
What is a 30-Year Fixed-Rate Mortgage?
A 30-year fixed-rate mortgage is a home loan that you will pay off over 30 years. It has a fixed interest rate. This means your monthly payments of principal and interest will remain the same for the life of the mortgage.
Read More: The Pros & Cons of Mortgages
Advantages of a 30-Year Mortgage
A 30-year mortgage is attractive to many homebuyers for the following reasons:
- Low payments: Payments are low because you're stretching out the repayment over 30 years. The lower monthly payment means it's easier to qualify for a mortgage, and you can buy a more expensive house with a lower income.
- Predictability: A fixed-rate loan means you have a fixed mortgage payment that makes it easier to plan for in your budget. The only variables in your house payment could be increases in real estate taxes and home insurance premiums.
- Flexibility: Even though the loan is set up to be repaid over 30 years, you can pay it off faster by making extra payments in addition to your regular payment. If your money is tight occasionally, you don't have to make extra payments. You can fall back to your regularly scheduled payment.
- Larger tax deduction: In the early years of the loan, most of your payment will go toward interest. Since mortgage interest is deductible on your tax return, you will get a higher deduction, which will reduce your taxable income.
- Can fund other financial goals: Because of the lower monthly mortgage payments, you should have income left that can be used to fund your other financial goals, like a retirement fund.
Disadvantages of a 30-Year Mortgage
A 30-year mortgage is not without its downsides.
- Higher interest rates: Lenders will charge a higher interest rate because they have a risk of non-payment for a longer number of years with a 30-year loan.
- More interest costs: Interest costs will be higher because you're paying interest for 30 years, rather than a shorter term.
- Slow buildup in home equity: Since most of your payment goes to interest in the early years, it takes longer to build up equity in your house.
- Risk of borrowing too much: The lower payments make it tempting to borrow more money and buy a bigger house. Larger houses typically cost more.
- Higher maintenance cost: If you take advantage of the lower payment to buy a larger house, you will also pay more in annual maintenance cost, property taxes and utility bills.
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What is a 15-Year Fixed-Rate Mortgage?
A 15-year mortgage is a home loan that you pay off in 15 years, instead of 30 years. It also has a fixed interest rate and a fixed monthly payment for the life of the loan.
Advantages of a 15-Year Mortgage
The advantages of a 15-year mortgage versus a 30-year mortgage are:
- Build equity faster: You’ll build up equity faster in your house because 15-year mortgages usually have lower interest rates, and you're making higher payments. The loan principal gets paid down more quickly. Suppose you had a $300,000 mortgage at 4 percent, and you have been paying for 10 years. The principal balance after 10 years would be $235,707. The principal balance on the same amount of mortgage on a 15-year plan at 3.25 percent would be $114,801 after 10 years. In this case, a 15-year mortgage would give you $120,906 in additional equity in your house.
- Reach ownership sooner: You’ll have your house paid off in 15 years instead of having to wait 30 years for full ownership.
- Less interest cost: Your total interest costs paid will be less. Take, for example, a $300,000 mortgage. The mortgage calculator shows that the total interest cost paid on a 30-year mortgage at 4 percent would be $215,608 compared to $79,441 in interest paid for a 15-year mortgage at 3.25 percent. This is a difference of $136,167 more in interest costs, unless you sell the house or refinance the mortgage.
Disadvantages of a 15-Year Mortgage
Homebuyers do not like 15-year mortgages for the following reasons:
- Higher monthly payments: Monthly payments for 15-year mortgages are about one-and-a-half times the payment for a 30-year mortgage. For example, the monthly payment on a $300,000 mortgage at 4 percent for 30 years would be $1,432. On the other hand, the monthly payment for the same mortgage amount at 3.25 percent for 15 years would be $2,108. This is a difference of $676 per month.
- Fewer funds available for other goals: The higher monthly payments required by a 15-year mortgage means you’ll have fewer funds for your other financial goals, like your retirement plan.
- Harder to qualify: The higher monthly payments of 15-year mortgages make it harder for you to qualify for a loan, and you may need a higher credit score. Consider that lenders generally don't want your mortgage payment to exceed 28 percent of your gross monthly income. This means you would need a monthly income of $5,114 ($1,432 divided by 0.28) to qualify for a $300,000 loan at 30 years. But you would need a monthly income of $7,528 ($2,108 divided by 0.28) to qualify for the same amount for a 15-year loan term at 3.25 percent.
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Consider a compromise. Go with a 30-year mortgage and make extra payments whenever you have enough income.
Which is Better For You? A 15-Year or 30-Year Mortgage
If you don't like spending money on interest, a 15-year mortgage is the way to go. But you need to be comfortable that you have sufficient income to support the higher payment in case you suffer a setback in your personal finances, such as a cut in pay or loss of job. If you don't have extra income or a large savings account, it's probably better for you to go with a 30-year mortgage.
Conversely, the lower payment of a 30-year mortgage is less risky and gives you more discretionary income to add to your emergency savings account or other financial goals, such as contributing to your retirement fund. A 30-year mortgage also would let you purchase a house that you might not be able to afford with the qualifications requirements of a 15-year loan.
Strike a Compromise
Still not sure which way to go? Consider a compromise.
Go with a 30-year mortgage and make extra payments whenever you have enough income. You could make higher payments as if you had a 15-year mortgage and be able to reduce the loan balance faster and build up more equity in your house.
If your cash flow gets tight, you can always make the lower payment of your 30-year mortgage without getting into any financial problems.
James Woodruff has been a management consultant to more than 1,000 small businesses. As a senior management consultant and owner, he used his technical expertise to conduct an analysis of a company's operational, financial and business management issues. James has been writing business and finance related topics for work.chron, bizfluent.com, smallbusiness.chron.com and e-commerce websites since 2007. He graduated from Georgia Tech with a Bachelor of Mechanical Engineering and received an MBA from Columbia University.