What You Need to Know: 30-Year Mortgage vs. 15-Year Mortgage

What You Need to Know: 30-Year Mortgage vs. 15-Year Mortgage
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When you’re shopping around for a home loan, the lower rates offered with ​30-year​ loans can be tempting. But a ​15-year​ mortgage has you paying off the loan faster, resulting in lower interest payments. Before you make a final decision, it’s important to look at the benefits of both ​30-year​ and ​15-year​ mortgages.

What Is a Mortgage?

Since homes typically run in the ​six figures​, most people need a loan to buy one. This type of loan is called a mortgage. A mortgage is typically drawn out over at least a ​15-year term​, and you pay mortgage interest on the amount you borrow.

Although there are other mortgage loan terms, you usually choose from a ​15-year​ or ​30-year​ mortgage. A ​15-year​ mortgage offers a more competitive interest rate, but a ​30-year​ mortgage gives you a lower monthly payment. You don’t have to remain in your home for ​15​ or ​30​ years. If you sell the home, the purchase pays off your mortgage, and any surplus will be yours, minus applicable fees.

How Does a Mortgage Work?

A mortgage is a loan that uses the home itself as collateral. If you default on the loan, the lender can recoup some of its loss by selling the home and keeping the proceeds. Although adustable-rate mortgages are available, the fixed-rate mortgage is most common. With a fixed-rate mortgage, you pay the same interest rate throughout the life of your loan.

The first step in taking a mortgage is to select from among the many mortgage lenders and get approved for a loan that meets your financial goals. Once you’re approved, you need to provide a down payment, which ranges from ​3 to 20 percent​ of the loan, and pay closing costs. Both of these are paid with money that is not part of the homebuyer's mortgage loan. Then you move into the home and begin making monthly payments, which will include a portion of your loan principal, interest, homeowners insurance and property taxes. If you make a lower than the optimal down payment, it will also include private mortgage insurance (PMI).

About 30-Year Mortgages

With a ​30-year​ mortgage, a lender takes care of purchasing the home in exchange for an agreement that you’ll pay the loan over ​30 years​. Your loan amount is divided by ​360​, which is the number of months in ​30 years​. Since it’s divided by ​360​, the principal amount will be lower, but you’ll also pay interest on the amount.

The lower monthly payments make ​30-year​ mortgages attractive, especially to budget-challenged borrowers. You can use a ​30-year​ mortgage calculator to see what you can expect to pay each month. You need a ballpark interest rate to more accurately calculate the payment.

About 15-Year Mortgages

As you’re shopping lenders, you’ll also come across the ​15-year​ mortgage. This option condenses your payments into a shorter mortgage timeframe, which means your principal, or the amount you borrowed, is divided by ​180​ instead of ​360​. Often lenders give you a better deal on interest if you take a ​15-year​ loan.

If you can’t afford the higher monthly payments of a ​15-year​ mortgage, there’s always the option to refinance later. Simply start out with a ​30-year​ mortgage, then as your financial situation changes, meet with a lender to refinance the loan into a ​15-year​ mortgage.

Comparing 30-Year vs. 15-Year Interest

Generally speaking, a ​30-year​ mortgage comes with a higher interest rate than a ​15-year​ mortgage. According to Freddie Mac, the current 30-year​ mortgage rate is just over ​3 percent​. In ​2020​, ​30-year​ mortgages averaged ​3.11 percent​. Compare this to the 15-year​ interest rate, which is currently ​2.36 percent​ and averaged ​2.61 percent​ in ​2020​.

Of course, plenty of things contribute to the actual rate you’re quoted. Your credit score and debt-to-income ratio both factor into the rate you’re quoted. The amount you’re borrowing, which can be reduced by a hefty down payment, also factors in. But you still save on the total interest cost with a ​15-year​ mortgage under those same circumstances.

Average Cost of 30-Year Mortgages

Although that small number might not seem like much when you’re closing on a mortgage, it adds up. It can be a big eye-opener. Whether you choose a ​15-year​ or ​30-year​ mortgage, the interest you pay over the life of the loan adds up significantly, depending upon the mortgage term, with the longer period costing more than the shorter term.

Using a loan calculator, at a 3 percent interest rate and a 3 percent down payment, a 30-year loan on a $300,000 house would total $441,673.20, with $150,673.20 as the total cost of interest. Your monthly mortgage payment would be $1,226.87. That doesn’t include the money you’ll pay for homeowners insurance premiums and property taxes.

Average Cost of 15-Year Mortgages

Making higher monthly payments may seem like a budget killer in the short term. But when you look at the long-term benefits of a ​15-year​ mortgage, you can see how much you actually save by paying less interest.

Calculating the long-term interest on 15-year mortgage on a $300,000 loan, you’d pay $361,726.20 and a total of $70,726.20 in interest. Your monthly mortgage payment before homeowner’s insurance and property taxes would be $2,009.59. That’s a savings of $79,947 over what you’d pay for the same loan in a 30-year variety.

Benefits of 30-Year Mortgages

The biggest benefit you get from a ​30-year​ mortgage is a lower monthly payment. Borrowers may find this is a good way to move from renter to homeowner while still keeping their monthly housing costs the same. This lower payment also means you can afford to move into a more expensive house than you could otherwise.

A ​30-year​ mortgage also gives you a little more flexibility in your payments. As your earning power increases during your time in the home, you can make extra payments to get to final payoff sooner. You can also refinance at some point to turn your ​30-year​ loan into a ​15-year​ one.

Benefits of 15-Year Mortgages

Assuming you stay in your house at least ​15 years​, you’ll eventually fully own your home with a ​15-year​ mortgage. But you will see a higher monthly payment. Whether you stay in your home ​five years​ or ​30 years​, more of those monthly payments go toward paying back the loan with a ​30-year​ loan, which has you paying a substantial amount of interest.

But perhaps the biggest benefit of a ​15-year​ mortgage is that you get a lower interest rate. Even a half a percentage point adds up over the years you’re in the home. But you’ll also be building equity in your home, which means when you go to sell it, you’ll be more likely to earn a sizable profit.

Your Loan Payment

Whether you opt for a ​30-year​ or ​15-year​ mortgage, your monthly payment include a mix of principal, interest and escrow. The principal is the portion of the money you borrowed, which you’re paying back in monthly installments. The lender takes the lump sum of the borrowed amount and divides it by the number of months.

Your monthly mortgage payment includes that month’s portion of the loan amount, interest and escrow. Escrow refers to the money your lender takes out each month to cover your homeowner’s insurance and property taxes. As you pay off more of that original loan amount, your interest goes down and more of that monthly payment goes toward reducing what you owe.

The Value of Equity

At some point every year that you’re paying on your home loan, the lender sends you a statement that summarizes how much of your principal loan balance remains. Since each payment includes a combination of principal, interest, homeowner’s insurance and property taxes, you’ll be chipping away at that principal amount every month.

The longer you’re in your house, the less you’ll owe. For many homeowners, the value of their home also increases during this time. This allows you to build equity in your home. With equity, you’ll someday sell the house for more than you owe on it, giving you extra money you can save, spend or use as a down payment on your next home purchase.

Another benefit of home equity is that you can borrow funds from it. Once your home is worth ​15 to 20 percent​ more than what you still owe on it, lenders consider you for a home equity loan, which refers to funds you borrow using the equity in your home as collateral. You may also qualify for a home equity line of credit, which gives homeowners access to funds they can borrow against as they need them.

Fixed-Rate vs. Variable-Rate Mortgages

When you’re shopping around for a mortgage, you’ll often find lower rates being offered in the form of a variable-rate mortgage. With a fixed-rate mortgage, you’re locked in at an interest rate that you pay throughout the entire life of the loan. Until the day you pay the loan off, that’s the interest rate you’re charged.

A variable rate, on the other hand, doesn’t lock in. You’re given a reduced rate in the early months, which then increases. These increases are at the discretion of the lender, but they follow an official index. That index typically adjusts along with the market, which means if interest rates increase, you could find you’re paying more in interest than you originally expected.

Alternatives to 15-Year Mortgages

If the higher monthly payments on a ​15-year​ mortgage aren’t appealing, there are some alternatives to consider.

Here are some ways to make a ​30-year​ mortgage work well for your financial health.

  • Pay extra:​ At any point during your loan term, you can submit some extra money. Make sure if you do that, you direct your lender to apply the overage to principal. Some online payment portals let you input the amount to apply to the principal while making your payment.
  • Make biweekly payments:​ Some borrowers choose to pay their mortgage twice a month rather than once. Biweekly mortgage payments have you paying half of your mortgage twice a month rather than the whole thing in ​one​ lump sum when it’s due. This drops the interest you pay over the life of a loan.
  • Pay off debts​: If you have debts like student loans or large credit card balances, a ​30-year​ loan could give you the extra freedom to pay those debts off. Compare the slightly higher interest you’ll pay on your ​30-year​ loan to the interest you’re paying on those other debts and see which option works better for you.
  • Invest the funds​: Once all your debts are paid, you may find that your lower mortgage payment lets you invest in property or the stock market. However, it’s important to weigh the interest you’re paying in your mortgage against any dividends you’re earning on investments.
  • Save the funds​: If your employer offers a ​401(k)​, you can slip money into that every month, especially if your employer matches your contributions. As important as it is to save, though, compare the interest you’ll earn to what you’re paying in interest on your longer-term mortgage.
  • Refinance:​ There’s always the option of starting out your mortgage paying lower payments on a ​30-year​ loan, then refinancing at some point. Not only might your income increase, you’ll also have some equity in the house after a few years, which means you can borrow a reduced amount.

While there are benefits to both a ​15-year​ and a ​30-year​ mortgage, there’s no single best mortgage. It’s important to crunch the numbers and look at how much you can afford. You may also find that starting with a ​30-year​ mortgage, then refinancing or putting the cost savings toward other expenses later, is a better financial move for you than taking a ​15-year​ mortgage. Take the time to review the options and see which is best for your personal finances.