When buying a home, you’d be faced with the quintessential question: How much can I afford? There’s the matter of how much of your income should be spent on your mortgage to be settled. Then as a follow-up, how much of this income should go to your mortgage’s interest. If you’re keen on saving on interest and fees and paying off your loan faster, the 15-year mortgage loan is up for your consideration.
Interest Savings Win
Your savings on the interest portion of the 15-year fixed-rate mortgage are primarily derived from its inherently lower rates and lower interest costs overall.
The 15-year mortgage rate is typically lower than its 30-year counterpart because its shorter-term spells less risk to the lender who can recoup the principal plus the interest within 15 years instead of three decades.
As of the week ending March 9, the 15-year fixed mortgage stood at 3.42% while the 30-year fixed mortgage at 4.21%. The difference between the two rates may be small but the interest paid throughout the life of the loan differs substantially.
Let’s assume you have taken out a $300,000 mortgage at today’s current rates to be repaid in 15 and 30 years.
- For a 15-year mortgage of $300,000 at 3.42%, your monthly payment is $2,132.88. Your total mortgage with interest is $383,918.61.
- For a 30-year mortgage of $300,000 at 4.21%, your monthly payment is $1,468.80. Your total mortgage with interest is $528,769.09.
Based on the given rates, you will pay $83,919 in interest in 15 years compared to paying as much as $228,769 in 30 years for the same amount borrowed.
Fees Fewer Than 30
You will also pay less in fees on the 15-year mortgage. This is because loan pricing adjustments prevalent in conventional mortgages sold to Fannie Mae and Freddie Mac are lower with, or do not apply to 15-year mortgages.
Annual fees on FHA mortgage insurance are also lower on mortgages spanning 15 years, although this may be reflected by a higher rate.
Higher Monthly Payments = Faster Equity Buildup
Because it amortizes on an expedited schedule, the higher monthly payments on the 15-year fixed-rate mortgage are expected. But these higher payments are principal-heavy even during the start of the loan, enabling you to build equity faster.
Your equity represents your investment in the home, something that would go up as your home value appreciates and your mortgage balance dwindles over time. This equity you can use for debt consolidation, university education and retirement.
Let’s see how the first year’s payments chip away at the theoretical $300,000 loan.
- On the 15-year loan, your payments will go more to the principal of the loan ($15,577) and less to the interest ($10,017).
- On the 30-year loan, your payments will go more to the interest of the loan ($12,532) and less to the principal ($5,093).
After the first year of your 15-year mortgage, your outstanding loan balance is $284,423 vis-a-vis $294,907 left on the 30-year mortgage. This structure enables you to pay off your mortgage twice sooner than with the 30-year loan.
The 30-year mortgage can afford to give you a lower payment because of its extended term but as noted above, these protractedly low payments make your loan costlier in the long run.
Understanding Your Mortgage Undertaking
The choice between $2,133 (15-year) and $1,469 (30-year) for a monthly mortgage payment is almost too easy.
Payments on the 15-year mortgage require more financial discipline, commitment and wherewithal. Not just the monthly payments but you need to have more cash reserves than required for a 30-year loan. Indeed, a chunk of your income/savings is tied to your home instead of investing it elsewhere for your retirement or college funds.
But any goals to reduce your borrowing costs and pay it off sooner would align better with the 15-year loan. You can try to lower your monthly payment on a 15-year loan by borrowing less money. It’s either you buy a less expensive house or make a sizable down payment.
Whatever your decision is, always weigh its pros and cons and think of its long-term effect on your finances.
Justin McHood is a managing partner at Suited Connector and has been recognized by national media outlets as a financial expert for more than a decade.