Mortgages: 15 vs 30 Year Term
Most people I encounter have a 30-year mortgage. I understand why because I have one, too. Simply put, monthly payments are more affordable. Purchasing a home is the biggest purchase most people will ever make, it’s the biggest investment most people make. Owing $200,000 or even $100,000 is nothing to sneeze at. It can be scary, especially as a first-time homebuyer. You sit down with your finance company/mortgager to determine the terms you qualify for. It’s better to know this ahead of time, before you find the house you love, than to do it on the back end. So you sit down and they look at your annual income, debt/credit ratio, credit worthiness, and other factor and determine you can afford this much house and at this rate. They won’t negotiate much- especially when dealing with persons inexperienced in the game. Now, it’s time to discuss terms. There can be a half dozen options (or more) you may be able to choose from, but let’s look at two of the most common 15-year or 3- year term? Which is better?
A Comparison
A 30-year term means you have a longer period to pay off your loan.
Because payments are stretched over a longer period, monthly payment amounts are lower.
Because payments are stretched over a longer period, interest paid is higher.
Example: A $200,000 mortgage loan at 5% interest, 30-year term, is $386,513.
Pro: Low simple mortgage payment of $1073.64.
Con: $186,513 interest (almost double original loan amount)
A 15-year term means you have a shorter period to pay off your loan.
Because payments are over a shorter period, monthly payments are higher.
Because payments ae over a shorter period, interest paid is lower.
Example: In comparison to the above, a $200,000 mortgage loan at 5% interest, 15-year term, is $284,685 vs $386,513.
Pro: $84,685 vs 186,513 in interest paid: a savings of $101,828 over the life of loan.
Con: Higher simple mortgage payment of $1581.59 vs 1073.64: an increase of $507.95/month.
As in this scenario, you could almost pay for two homes by spreading your mortgage
payments over a 30-year term vs a 15-year term. You could save over a hundred thousand dollars just by opting for the shorter term. If you can’t afford the higher payment, you could consider a 20-year term. It won’t be as great as a 15-year term, but still save you tens of thousands compared to a 30-year term. Otherwise, consider buying less house. Instead of a $200,000 home, maybe you can opt for a $175,000 home or $150,000 home.
Some people say, take the 30-year term and pay on a 15-year payment plan. In our scenario, that would be, paying $1581.59 instead of $1073,64 every month for 15 years. In theory that works. You will have virtually the same interest savings as if you opted for the 15-year term, but if you hit a rough patch, you won’t be obligated to pay the higher payment. You could ride out your rough patch by paying the lower scheduled payment amount.
Some people actually pull it off- but very few. For most, though well intended, life always seems to get in the way. They never actually do what they planned. Because they are not contracted to pay on a 15-year term, they end of making minimum payments, over the course of 30 years or more.
Conclusion
All financial experts agree on the math as far as the interest savings gained from a shorter loan period. That’s probably as far as agreement goes. Personally, I like the idea of a longer loan and being able to pre-pay to the principal and save on interest. Life does happen, and those lower payments can be a life saver when you hit a rough patch. But I also know that I promised to do that when I purchased my home, but it was 15 years later before I actually started doing it. Maybe that’s your story, too. It wasn’t that I couldn’t afford to do it, I just didn’t know the basic financial principles, like living on a budget, avoiding unnecessary debt, and having an emergency fund.
I wish I started 15 years earlier, but I still have the benefit of saving tens of thousands, now; and so do you. If it doesn’t benefit you to refinance to a shorter term and hopefully a lower interest rate, that doesn’t stop you from making pre-payments as if you were. Just increase the amount you are paying each month. Even $50 or $100 will save you thousands. The internet is full of pre-payment calculators to help you determine your interest savings; and even help you determine whether it’s cost effective to refinance (i.e. at Compass) You can start where you are. You can start, today. Grow as you go!
