It’s a trade off between time and money. When deciding whether a 15-year or a 30-year fixed-rate mortgage is right for you, there are many factors to consider. There is not one answer that applies to everyone as both types of mortgages have their advantages and disadvantages. Read on to find out more about these mortgages, as well as a compromise that gets you the best of both worlds.
30-Year Fixed-Rate Mortgage
According to Freddie Mac, 90% of home buyers chose a 30-year fixed-rate mortgage in 2019. The affordability of monthly payments makes this mortgage a default choice for most home-buyers, especially first-time home buyers. However, there are significant drawbacks as well.
This is the most common mortgage for several reasons. The draw of the 30-year mortgage is that it has lower monthly payments than the 15-year mortgage. This also means that a borrower can buy a more expensive house with a 30-year fixed-rate mortgage because the monthly payments are lower making the borrower’s debt-to-income ratio lower. Moreover, a borrower can build up more of a savings or use their money for other financial goals due to this lower monthly payment. Unexpected costs or unforeseen circumstances, like losing a job, may arise which makes the lower monthly payment of the 30-year fixed rate mortgage very attractive.
Due to the longer term of this mortgage, the interest rate is generally higher than that of a 15-year mortgage. This is because it takes twice the time for the lender to get their money back, so the interest rate must offset the risk. Obviously, the length of time a borrower will be paying off the 30-year mortgage is double, but the amount of interest is actually more than double.
We compared 15-year and 30-year fixed rate mortgage loans to buy a $300,000 house with 20% down ($60,000). Even if the interest rates were identical, say 4%, the borrower of a 30-year mortgage will pay 2.17 times the interest over the course of the loan compared to the 15-year, or about $93,000 more. Of course, when a borrower gets the rates for these mortgages from a lender the interest rates will not be the same so there will be an even larger difference.
15-Year Fixed-Rate Mortgage
The younger sister of the 30-year mortgage, the 15-year fixed rate mortgage offers less interest and less time in debt, but at a higher monthly cost. Although this mortgage makes it less affordable to buy a house, borrowers will build equity faster.
According to Rocket Mortgage, borrowers can expect to have a lower interest rate of 0.25% to 1% when selecting a 15-year fixed rate mortgage instead of a 30-year. This means that not only are borrowers paying off the loan faster, but with a lower interest rate they are saving a significant amount of interest. A savings of tens of thousands to hundreds of thousands of dollars! Borrowers consequently build equity in their home faster and are free of monthly payments in half the time.
The catch is that the monthly payment for a 15-year mortgage will be much higher than that of a 30-year mortgage. In fact, you can expect to pay about 30-40% more each month with a 15-year mortgage. As a result, a 15-year mortgage is less affordable than its counterpart. The higher monthly payment may leave little wiggle room in a borrower’s budget if something unexpected occurs.
Ultimately, you as the borrower have to weigh the pros and cons and think in both the long and short-term before you make a decision about your mortgage. Consider your financial goals and how both of these mortgages affect them. This decision can impact your finances for decades if you stay in the house for the term of the loan, so don’t take this decision lightly.
If the higher monthly payment of the 15-year mortgage makes you uncomfortable, but the amount of interest over the course of the 30-year mortgage shocks you, then there is a compromise to be made. Get the 30-year mortgage and pay it off faster - the best of both worlds. It’s important to note that this option is only available if your mortgage has no prepayment penalty, which you should find out from the lender. You can pay as much as you would in the 15-year mortgage on a monthly basis without the commitment to do so in case something comes up. Learn more about paying your mortgage off faster in our article, Should You Pay Off Your Mortgage Early?