Dont Forget About Retirement
Hows your retirement fund? Check on this and see if youre currently contributing enough. Instead of refinancing to a 15-year mortgage, you may be better off putting more money toward a 401 plan or an IRA account.
You also want to make sure youre maximizing your tax benefits in these and other types of programs, like health savings accounts and 529 college savings accounts. Compared to these plans, paying down a low-rate, potentially tax-deductible debt like a mortgage is a low financial priority.
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So What Is The Answer To A 15
Although generally it is said a 15-year mortgage is better by a number of financial professionals, it isnt always the best choice as many of them would argue. It is not the only best decision as many of them would tell you. Not everyone comes from the same background, has the same lifestyle or even the same income. How can a 15-year mortgage always be the better selection? The answer is it cant. It is important not only to be realistic when it comes to purchasing a home but also to make the smartest decision possible.
Yes, there is a need to have 15-year payments on a home. However, life does happen and it is unpredictable. Having the cash flow to be there for challenging times can make a difference. This may be through having a lower monthly payment in general or earning more money by investing the difference in having a 30-year term.
For me, there is peace of mind for owning a home and paying it off. The interest rate on a 30-year mortgage may be slightly higher than 15 years. But the extra interest is insurance. We all buy insurance on things. There is life insurance, car insurance and home insurance. A slightly higher interest rate for a lower monthly home payment insures that it may be more affordable to stay living in my home. It is just added homeowner insurance.
With my mortgage, there is no penalty for paying it off early. If there is extra money this can be put toward the payment each month, but if the amount needs to be lower at some point it already is.
But How To Pay The Extra Amount
It would be nice if that $555 in monthly savings was in your pocket from the beginning. But its not. Its the savings youll see after the loan is paid off.
The main difficulty with a 15-year loan is increasing your monthly payment. In the above case, its by $466. Putting that $555 monthly savings into the mortgage would more than pay for it.
But where do homebuyers get money now so they can afford a much higher mortgage each month for the next 15 years?
Because less than 10 percent of homeowners have 15-year mortgages, Bechtel says its not an option for everyone, mainly because of the higher payments.
Its not for the faint of heart, he says.
Borrowers should make sure they have enough income to afford it, are able to manage their household debt, and have money in liquid savings for emergencies, he suggests. This is mainly why 15-year mortgages are more of a refinancing option, says Bechtel, who bought his house with a 30-year loan and later refinanced into a 15-year loan that now has six years remaining.
If Im going to swallow a bigger monthly nut, knowing that Ill save a ton of money in the long run, Bechtel says, a borrower needs confidence in their job prospects or have enough money in savings to cover the higher mortgage if they lose their job or their salary drops.
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Consider Your Other Goals
A 30-year mortgage makes it easier to save for retirement. Youll have more free money in your budget to put toward long-term goals instead of making a hefty mortgage payment every month. However, you might not be better off with a 30-year loan if you spend that extra money on wants and luxuries each month.
Scenario : Invest Gradually While Paying Off Your Mortgage In 30 Years
First, well see how much a $500,000 home will cost over time with a 30-year mortgage. Remember, Monica is putting the full 20% down, meaning her loan will be for $400,000.
With a monthly mortgage payment of $2,350, Monica will pay a total of $845,842 over the 30-year term of the loan, including a whopping $445,842 in interest payments.
However, the lower monthly payments also allow her to begin growing a nest egg in the stock market much earlier. Since her mortgage payment is $797 less than what it would be with a 15-year mortgage, Monica invests that money every month and watches it grow to $977,952 over the course of the 30-year period. Not bad at all!
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When To Consider A 30
You can likely claim a sizable tax deduction based on interest payments for your 30-year loan, especially in the early years, when most of your payments go toward interest. And because its a fixed-rate loan, youll pay the same amount every month.However, if you dont plan to stay put for several years, or if you want a lower rate, a 15-year fixed-rate mortgage or an adjustable-rate mortgage might be a better option.
Youll Build Equity In Your Home Faster
One way to build equity is to pay back the principal balance of your loan, rather than just the interest.
Since youre making bigger monthly payments on a 15-year mortgage, youll pay down the interest a lot faster, which means more of your payment will go to the principal every month.
On the flip side, the smaller monthly payments of a 30-year mortgage will have you paying down the interest a lot slower. So less of your monthly payment will go to the principal.
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Monthly Mortgage Payments For 15 Vs 30
Mortgage payments on a 15-year loan will likely be several hundred dollars more than for a 30-year loan.
Imagine you take out a $250,000 loan over 15 years at 2.50%, says Tom Trott, branch manager with Embrace Home Loans. Your monthly principal and interest payments will be $1,667.
On the other hand, A 30-year mortgage on the same loan amount at 2.99% will trigger monthly payments of $1,053 $614 less, he explains.
Of course, the exact payment amounts will depend on your credit score, down payment, interest rate, and other factors. So its worth comparing both loan types before you buy to see how your options break down.
Pros And Cons Of A 30
With a 30-year mortgage, your monthly payment will be lower than with a 15-year loan, which makes those payments fit more easily into your budget. On the other hand, you’ll pay more interest over the life of your loan because you’ll have:
Many people can’t afford the higher monthly payments that come with 15-year loans, so if that’s the case for you, a 30-year mortgage could be your ticket to homeownership sooner rather than later. Just be aware that you’ll be paying off that home loan for a very, very long time.
Check out our 30-year mortgage rates here.
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Is It Better To Pay Lump Sum Off Mortgage Or Extra Monthly
Regardless of the amount of funds applied towards the principal, paying extra installments towards your loan makes an enormous difference in the amount of interest paid over the life of the loan. Additionally, the term of the mortgage can be drastically reduced by making extra payments or a lump sum.
Can You Change Your 30
Refinancing from a 30-year, fixed-rate mortgage into a 15-year fixed loan can help you pay down your loan sooner and save lots of dollars otherwise spent on interest. You’ll own your home outright and be free of mortgage debt much sooner than normal. Plus, mortgages with shorter terms often charge lower interest rates.
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Why Would You Want The Flexibility Of A 30
The interest rate for a 30-year fixed mortgage will be higher than 15 years. However, one thing that will not be fixed is life. There is no way to tell what the future holds. Most of the time a 30-year mortgage payment will be lower compared to a 15-year. To some people, the difference may not be much. But to other people, it may be a significant amount that may make a difference if something were to happen.
Job loss, rising healthcare costs, and the unknown are reason enough to have the flexibility of a 30-year mortgage. What if your mortgage payment was, for example, $2000 per month on a 15-year term and it was $1500 a month on a 30 year? Would $500 a month make a difference if a job loss occurred? Wouldnt the extra $500 go a little further rather than possibly depleting an entire emergency fund even if there is one?
I would encourage anyone that is purchasing a home to have a good emergency fund established. The typical period conveyed is usually three to six months. Yet, the truth is that depending on the education, job experience, and age of a person, three to six months may not be enough even in a good economy. For people that are older, it can often take much longer to find comparable employment following a job loss.
Better Returns May Be Possible on Another Investment
A 30-Year Mortgage May Afford a Better Home
Parameters Of Our Analysis
Before we delve into our comparison between a 15- and 30-year mortgage, its important to note some of the assumptions we made. First, we based our calculations on the purchase of a $500,000 home with a 20% down payment . Using Freddie Mac data, we also compiled the average interest rates for 30- and 15-year mortgages as of June 23, 2022 and calculated the monthly payments for each .
Next, we assumed our hypothetical homebuyer Monica has $3,147 in her monthly budget for housing. Why $3,147? Because thats how large a monthly mortgage payment would be for a $400,000 home loan on a 15-year mortgage.
The long-term growth of Monicas investment portfolio is another important component of our analysis. After paying off her 15-year mortgage, we assumed she would begin investing her full monthly housing budget in the stock market and have an average annual return of 7% over the next 15 years, slightly less than the S& P 500s historical average.
But since the 30-year mortgage comes with lower monthly payments stretched out over 30 years, we calculated how much Monica would stand to make if she invested the difference between monthly mortgage payments in the stock market every month for 30 years. To do this, we assumed the same 7% average annual rate of return.
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Interest Rates For 15
Traditionally, a 15-year mortgage loan comes with a lower interest rate than a 30-year mortgage. Thats because, by agreeing to pay off the debt more quickly, 15-year borrowers present less risk to mortgage lenders.
Differences in rates between 30-year and 15-year options have ranged, on average, from 0.5% to 0.75%, says Rob Heck, head of origination at Morty.
Just look how 15- and 30-year mortgage interest rates compare over the past six months, based on survey data from Freddie Mac:
How Can I Pay Down A 30
You have options to pay off your mortgage faster even with a 30-year mortgage. You can choose to make biweekly payments instead of the regular monthly payment, meaning youll make one extra full payment over the course of the year. You can also choose to make a larger payment each month. Be sure to ask your lender to apply your extra payments to your principal balance.
One word of caution: Double-check that your mortgage doesnt have a prepayment penalty before going this route. Most of the time, such a penalty only applies if you pay off your entire mortgage early. But in some cases, you might face a fee if you make small payments toward principal ahead of time.
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When Is A 15 Year Mortgage Better Than A 30
When it comes to traditional mortgages, there are two major options 15-year and 30-year. The vast majority of borrowers choose the 30-year option because it allows for lower monthly payments at the expense of more interest over time. However, there are definite benefits to 15-year mortgages, and learning more about them can help you make better financial decisions.
#1 When You Want to Be Free of Payments More Quickly
The number one reason why you might opt for a 15-year mortgage has to do with the time it takes to achieve homeownership status. If you want to own your home outright in very little time, then a 15-year mortgage is undoubtedly the way to do it. In fact, with certain lenders, if youre able to make the equivalent of one extra payment each year, you can own your home in about half of that time roughly eight years. The sooner you own your home, the sooner you can start saving for retirement and living the life youve always wanted.
#2 When You Want Lower Interest Rates
When you take out a 15-year loan as opposed to a 30-year one, there is less risk for your bank. Theyll receive their money from you more quickly. Think of it as an auto loan. Youre given options at the start. You can borrow money for anywhere from two to six years , but the shorter your term, the less interest you pay. This is significantly true for mortgages, too. The average interest rate savings for a 15-year loan is 0.70% and that adds up very quickly.
Should You Choose A 15
Theres a good reason that 30-year mortgages are typically the more popular choice for homeowners they come with lower monthly payments and can provide more purchasing power. While 15-year mortgages do have some advantages, especially when it comes to paying less overall interest, the higher monthly payments may be difficult for most borrowers to swallow.
However, if you do end up with a 30-year mortgage, its a good idea to try to make extra payments on your loan each year if you can. You can either plan out a faster overall payment plan or just make an extra payment whenever you have the money. Either way, those extra payments will help you save on interest, pay off your mortgage quicker and potentially give you the best of both worlds.
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The Main Downsides Of A 30
The most obvious disadvantage of a 30-year mortgage is that itll take twice as long for you to own your home outright, which means a longer duration until you have financial freedom from your housing payment.
But Nicole Rueth, producing branch manager at Fairway Mortgage in Englewood, Colorado, also points out that the lower monthly payment of a 30-year mortgage comes at an additional cost, with 30-year mortgages carrying higher interest rates. Combined with the longer term, that results in paying much more in total interest over the life of your mortgage.
According to a recent Bankrate mortgage survey, average interest rates on a 30-year fixed-rate mortgage are currently 3.75% as of mid-January, which is significantly higher than the historic lows we saw in 2020. But in the same survey, the average rate on 15-year mortgages was just 2.92%.
That means youre paying over 0.8% more for a 30-year mortgage, which may not sound like a lot. But on a $200,000 home with a 20% down payment, youll pay a total of $37,781 in interest over the entire length of a 15-year mortgage at 2.92%, while the same home with a 30-year mortgage at 3.75% ends up costing a whopping $106,754 in total interest.
Pay Off Your Home Prior To Passing
If youre older and dont expect to live 30 more years, Mescher says you should look at a shorter-term mortgage if you want to leave your home to your children free and clear of debt. A 15-year mortgage allows you to pay off your home debt faster, and increases the likelihood that youll own 100% of your home prior to your passing.
Of course, if youre buying a home that you dont expect to live in until the end of your life, this may not be a concern. But even then, youll still have more equity in your home with a 15-year mortgage if you decide to sell it in your later years.
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Why Is An Arm Less Risky Than You May Think
There are obviously some risks involved with an ARM because the rate can go up after 5 or 7 years. I always have plenty of reserves and cash flow to make sure I can afford the higher payment if the rates adjust. Even if I hold the loan well past the initial fixed-rate term, it takes a few years for the ARM to become more expensive than a fixed-rate mortgage. Chances are rents will increase in the time period as well. If you have enough cash flow and a plan for when rates could increase, you should have no problem with an ARM.
If you dont have enough cash flow and your payments go up, you could get into trouble with an ARM. Negative cash flow is hard to sustain and it will make it harder to qualify for loans as well.
Many lenders will also only offer ARM loans after you have a certain number of mortgages in your name. I would suggest getting the fixed-rate mortgages when first starting out, and as you advance in your investing career look at the ARM option.
