When buying a new home or refinancing an existing home, one of the many decisions that must be made is what kind of mortgage you’re going to get. With that decision, is the option of term – or the length of your loan (ex: a 30-year loan has payments spread out over 30 years). For most borrowers, this means choosing between the ever-popular 30-year or 15-year fixed-rate mortgage.
Before you decide what mortgage is best for you, make sure you weigh the pros and cons of each to determine which option is right for your personal financial situation.
Interest: Is Paying Less Always the Best Option?
Generally, the 15-year interest rate is lower than the 30-year interest rate. At first glance, this may make the 15-year seem like a more attractive option. But keep in mind that in exchange for a lower mortgage rate, your monthly payment is likely to be quite a bit higher.
What many people don’t know is that the majority of your mortgage payment for roughly the first half of the mortgage goes primarily toward paying interest and very little principal. For a 30-year mortgage, this means that you are not significantly chipping away at the principal balance of your mortgage until about the 15 year mark. With a 15-year mortgage, however, your payoff period is shorter, which means you’re getting the interest out of the way faster and therefore paying down the principal balance sooner and at a much faster rate.
In the long-term, a 15-year mortgage is less expensive than a 30-year mortgage because you pay less overall interest. On the flip side, if you have a better place for your money – e.g. you think you can earn more interest on your money than you’d pay on your mortgage – then you may want to opt for a 30-year mortgage to give you increased cash flow for your other investments or life goals.
Payment: What Can You Afford?
In the short-term, however, you’re responsible for making each of your monthly mortgage payments or risk severely damaging your credit score and your chances of getting another mortgage in the future. So, it’s imperative that you choose a mortgage that you can afford.
In general, a 30-year mortgage offers lower monthly payments because the repayment schedule is spread out over 15 more years. If you can afford the higher 15-year payment however, it may be the best option because it saves you money in the long run.
Still on the Fence?
If you’re still on the fence about whether to get a 30-year or 15-year mortgage, you may want to consider alternatives. For example, if you can afford the 15-year option, but it would require that you lower your savings or retirement contributions, you may want to consider taking on a 30-year mortgage then making extra payments when you can. That’s right! You can make extra payments on whatever loan term you have to effectively duplicate a shorter term without the obligation.
Another option is to get the safe, lower-payment 30-year mortgage, then look into refinancing when your income increases or your other debt obligations decrease. No matter what term you choose, you should be able to comfortable afford your monthly mortgage payment. If you’re even a little bit iffy about whether you can, take the conservative route, get the longer-term mortgage and refinance later when your situation becomes more certain.
Whether a 15-year or 30-year mortgage is a better option for you does not have a simple answer. Which one is right depends a lot on your personal financial situation and your intentions for the home you are buying or refinancing. Make sure you talk to your trusted mortgage banker or financial adviser about your options and what makes the most sense for you.
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