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I am going to talk about the difference between a 15-year mortgage and a 30-year mortgage. For starters, a 30-year mortgage has a longer term, so your monthly payments will be lower, but your interest rate on the loan will be higher. With a 15-year mortgage, your monthly payments will be higher, but your interest rate on the loan will be lower. The real question is, which one is better?
Let’s take a step back for a moment and talk about what a mortgage is and why it’s important to choose the right one. A mortgage by definition is an agreement between you and a lender that gives the lender the right to take your property if you fail to repay the money you’ve borrowed plus interest. Mortgage loans are used to buy a home or to borrow money against the value of a home you already own.
At a glance, the biggest difference between a 15-year and a 30-year loan is the required monthly payment. Aside from that, most people don’t give it a second look.
According to Freddie Mac, 90% of home buyers chose a 30-year mortgage, Why is that? When buying a home, you’re always looking for ways to save money up front so you have more funds to put toward new things for the home, an emergency fund, furniture, etc. Buyers are so focused on what their monthly payment is, that they lean more toward the cheaper option on paper instead of understanding the long term game.
The thought process when choosing a 30-year mortgage is, “I can always pay off the loan faster if I want by making extra payments each month” which is great and all, but most don’t follow through with that plan as those funds can be used elsewhere from month to month.
Just to give you an idea of the 15 and 30 year mortgage comparison, I’ll throw a quick example at you provided by thebalance.com. Let’s say you’re borrowing $200,000 to purchase a home, and you’re stuck on whether or not to choose the typical 30 year mortgage or venturing into the 15 year mortgage, and just for the sake of this example we will use an interest rate of 4.10% for the 30-year fixed-rate loan and a 3.43% interest rate for the 15-year fixed rate loan. If you’re wondering what the rate would be for you approximately, find a mortgage calculator online to get a general idea.
The mortgage payment for the 30-year loan is $966 a month and the mortgage payment for the 15 year loan is $1,432. After seven years the remaining loan balance on a 30 year loan would be $172,513 and the remaining balance on a 15 year loan after seven years would be $119,674. Over the course of the loan, you’ll pay less interest with a 15 year loan. In this example, you’ll pay $56,122 in interest alone for the 15 year loan and you’ll pay $147,903 in interest on a 30 year loan. After taking a look at the example, it might be obvious what the choice would be best in the long run, but Let me break down the pro’s and cons’ for a 15-year loan and a 30-year loan to add a little more perspective into reality, I'll start with a 30-year loan.
The biggest eye catching pro to getting a 30-year mortgage is paying a lower monthly payment and stretching out the repayment another 15 years. It also offers flexibility as I mentioned before, you can pay the loan off faster by making a few extra payments once in a while, but as I said, most people don’t. You could also make it a point to understand how much it would cost for a 15 year loan monthly payment, and take the difference between that and a 30 year monthly payment and put that access in stocks or investments. Treat it like a 15 year mortgage and hold yourself accountable to invest. The stock market averages 8% growth annually, so it could be a great payoff for you down the road.
If you decide to go with a 30 year mortgage make it a point to make a few extra payments if and only if you have the funds laying around. The last thing I’d recommend is for you to make a few extra payments and you’re now stuck eating ritz crackers with ketchup on them because you pulled from your grocery budget. Don’t do that!
One of the biggest reasons homebuyers get a 30-year mortgage is because they are much easier to qualify for. Obviously if your monthly payments are less, it creates a bigger appeal for people who may not have the largest income to purchase a home.
With that in mind, 30 year loans allow you to fund other ventures or hobbies. I know it’s not a mind-blowing pro to getting a 30 year mortgage, but having money leftover each month allows you to buy other things, so take that for what it is.
Lastly, A 30-year mortgage will also have a meaty tax deduction as tax laws allow home buyers to deduct mortgage interest in their taxes, and in the beginning years of a loan, most payments will go toward paying off the interest of the loan.
Now let’s dive into some con’s. As I mentioned before, with a 30 year loan, you have a lower payment but a higher interest rate, but why is it higher you may be asking? Believe it or not, it’s risky to give someone a 30 year loan and expect them to pay it back, a whole bunch of “what if’s” come to mind in a lenders head. Due to higher risk, they simply charge a higher interest rate as a safety measure.
As you saw by the example I laid out for you earlier, it’s clear as day that you’re paying much more in interest with a 30 year loan. While the interest piles up, the equity growth is like a turtle in the jack rabbit race. With a longer term, comes slower equity growth.
Now let’s dive into the pros and cons for a 15 year loan. For the pro’s, First and foremost, you’ll save thousands of dollars in interest paid as I mentioned before. While equity growth is slow in a 30 year loan, it’s twice as fast in a 15 year loan, and of course, you’ll be able to pay off your home twice as fast too.
When it comes to the cons of a 15 year loan, your monthly payments are higher, and that could prevent you from saving for things that are important such as retirement, emergency fund or a brand new motorcycle during your mid-life crisis. Another downside of a 15 year loan is the qualification is a little tighter than it is with a 30 year loan, as you’re paying more monthly, it requires you to have a more sizable down payment and/or higher income coming in monthly as well depending on your situation. One of the biggest cons to getting a 15 year loan that oftentimes changes the minds of most people looking to do so is the “what if” situations. If you haven’t noticed, your life and the economy tends to be a very up and down roller coaster, so it definitely has more risk of default and foreclosure on the home.
When it comes to deciding what mortgage is best for you, consider asking yourself the following questions: Are you planning on staying in the home for 10+ years? Are you retiring soon? Do you have a strict savings plan?
All these questions can help you decide what mortgage option is best for you. If you’re thinking about living in a home for over 10 years, what’s the rush in paying it off so quick? If you’re going to retire soon, you probably don’t want to be strapped down with a mortgage, if you’re a strict saver, you might not want to put it all toward a mortgage each month. Just a few things to consider!
The truth is, there’s no right or wrong option, it’s solely based on your situation and the goals you have for the future. If you’re young or old, a traveler or a saver, do yourself a favor and take some time to construct the pro’s and con’s of each and compare it to your lifestyle. This decision will impact your finances for years to come.
If your goal is to pay off your mortgage as fast as you can and allocate the funds toward that instead of having excess funds for hobbies and other ventures, the 15 year loan may be for you. If you’re wanting a lower monthly payment to do some cool DIY stuff in your home or take a few extra vacations, a 30 year loan just might be the one for you.
The big question is: What would you choose and why? Drop a comment below
Andrew McManamon is a Michigan REALTOR® with Signature Sotheby’s International Realty and provides real estate services to Buyers, Sellers and Investors throughout SE Michigan including Livingston County, Oakland County, Washtenaw County, Genesee County & beyond. Andrew has become one of the rising stars of Michigan real estate agents. Prior to his real estate career Andrew was responsible for managing a senior living facility in Brighton, Michigan as a dining supervisor and an activities assistant. Andrew’s passion to help people is unlike any other, and he continues to strive to be best resource he can be. Andrew graduated from Cleary University in Howell, Michigan with a double major and currently resides in White Lake, Michigan.