Shopping for a mortgage involves many decisions. Not only do you have to worry about the interest rate that the lender quotes you, but you also have to determine what term you are comfortable taking. Most people take either a 15 or 30-year fixed rate mortgage. They are simple programs that keep your mortgage payment predictable without any surprises like an adjustable rate would provide. How do you decide between the 15 and 30-year term, though?
The Main Difference
First, you should understand the main difference between the 15 and 30-year fixed rate mortgage. On a 15-year term, you pay mostly principal because you have to get the principal paid off in 15 years. With a 30-year term, you have a longer time to pay the principal down, which means more interest in the end. The benefit of choosing the 30-year for many people, however, is the lower payment it provides. With 30 years to spread out the principal, you have much lower monthly payments to consider.
Interest Rate Difference
Another vast difference between the 15 and 30-year term is the interest rate. Lenders base the interest rate they provide you on the risk you pose. They look at things like your debt ratio, credit score, past payment history, and loan-to-value ratio. These have a direct impact on the adjustments they have to make to the base interest rate. However, 30-year term interest rates are always higher than 15-year term rates simply because you have the bank’s money for a longer period. The lender takes a much higher risk in allowing you to pay your loan back over 30 years rather than 15, so they make up for that risk by giving you a higher interest rate.
Afford More Home with a 30-Year Fixed Rate Mortgage
If you are in the market to purchase a home, the type of term you pick will have a direct impact on what you afford. If you know you want a 15-year fixed rate mortgage, your buying power decreases based on your debt ratio. The higher 15-year payment increases your debt ratio, which directly impacts how much you can afford. If you opt for the 30-year term, your payment decreases, which means you can likely afford a more expensive home.
Think of the Long-Term
Aside from determining what you can afford right now and possibly in the future, you should consider your future plans. Do you have children that will attend college? Do you have an account set up for retirement? What other long-term expenses do you foresee? If you do not have money set aside for these occurrences yet, choosing a 15-year term might hinder your ability to do so in the future. Before you choose the term right for you consider your future to see how the mortgage affects you in the long run.
Building More Equity
A great advantage of the 15-year fixed mortgage over the 30-year term is the amount of equity you build up in a short amount of time. The 30-year payment focuses on interest in the beginning stages of the loan, which means it takes a long time to build up equity. A 15-year term, on the other hand, pays principal down right away, which helps you to build equity faster. This gives you a better return on your investment as well as gives you the cushion you need to refinance, should you run into financial trouble down the road.
Choosing a 30-Year Term and Making 15-Year Payments
If you find that 15-year fixed rate mortgages are too expensive for you right now or that you are not comfortable taking on such a large payment, you have another option. You can secure the 30-year term, but make 15-year payments when you can afford it. This gives you the best of both worlds:
- You have the security of the lower required payment should you run into financial difficulty and not be able to afford the 15-year payment
- You have the option to pay off the 30-year mortgage in a shorter amount of time as you can afford it
Choosing between a 15 and 30-year fixed rate mortgage is a personal decision. You must look at all of the factors that play a role in your affordability. Looking at future plans as well as your current obligations can help you determine your level of comfort with mortgage payments. In addition, determining the price of the home that will satisfy your needs will help you determine the term that will best fit your needs. Make sure to go over each option with several lenders to see every option you have at your disposal to help make the biggest investment decision you will make in your life a profitable one.