There is no shortage of decisions to be made when applying for a new mortgage loan. You have to select a lender and decide between a fixed or an adjustable rate – and then you must make the biggest decision of all. Is a 15 or 30 year mortgage right for you? Paying on a mortgage loan for 30 years is typical, and in fact, many homebuyers assume they need to accept a 30-year mortgage term. However, this standard mortgage length is not written in stone, and you can choose to pay off your mortgage sooner with a 15-year loan. Advantages of a 15-Year MortgageThere are several benefits of a 15-year term:
Pay Off the Mortgage Faster. One of the biggest benefits of a 15-year mortgage term is the ability to quickly pay off your home loan. This option is perfect if you plan to stay put and don’t want to pay your mortgage for a lengthy period of time. Mortgage payments are huge expenses, but with your payment out of the picture, you can focus on other things like preparing for retirement, working less hours, and enjoying the freedom of not having a mortgage payment.
Save Money on Interest. If you’ve ever taken out a loan, you’re familiar with interest and how quickly it can add up. Factors such as your credit score and down payments can affect the interest rate on a mortgage. However, the shorter your finance term, the less you pay in interest; therefore, choosing a 15-year mortgage over a 30-year mortgage saves you a ton of money in the long run. For example, if you finance a property for $200,000 at 4% interest over 15 years, you’ll pay $66,288 in interest. However, if you finance a home for the same amount with the same interest rate for 30 years, you’ll pay a whopping $143,739.
Build Equity Faster. Equity is the difference between your house’s value and what you owe your home loan lender. Home equity builds as your property value increases and your mortgage balance decreases. Unfortunately, equity builds slowly with a 30-year mortgage because it takes longer to pay down the principal balance. However, since you pay less interest on a 15-year mortgage, you can build equity at a faster rate.
Before making a final decision to apply for a reduced term mortgage, it’s important to note that shorter mortgage terms aren’t right for every buyer. The higher monthly payment is a major drawback and may not be feasible for you if you are on a tight personal budget. Plus, once you sign your mortgage papers and agree to a 15-year mortgage term, you’re obligated to make these higher payments for the duration of the home loan. Advantages of a 30-Year MortgageEven if you recognize the advantages of a reduced home loan term, it doesn’t hurt to explore the benefits of a traditional 30-year mortgage as well. Longer mortgages involve additional interest, but they can make good financial sense for many buyers.
Lower Monthly Payment. The ability to make low, affordable monthly payments can outweigh the benefits of a 15-year mortgage. Financial situations can change immediately – one day you’re earning big bucks, and the next day you’re at the unemployment office. Going with a traditional mortgage term and keeping your payments low can provide a measure of security and peace of mind. A longer term alleviates a larger monthly mortgage debt, allowing you to better manage financial mishaps.
Extra Cash to Increase Your Savings. Sticking with a 30-year mortgage and keeping cash in your pocket gives you the opportunity to increase your personal savings. You can pay off credit card debt with the extra money, or make home improvements to increase the value of your property. After accomplishing these goals, you can always add extra money to your mortgage payments on a voluntarily basis. This simple move helps pay down your balance sooner – but unlike a 15-year mortgage term, you can stop making higher payments at any time.
Monthly Payment DifferenceIf you’re paying off your home loan with a 15-year mortgage term, it’s reasonable to expect an increase in your monthly home loan payment as opposed to a 30-year term. However, paying off a mortgage in half the time does not double the mortgage payment.
For example, if you were to take out a $200,000 mortgage loan for 30 years and pay 4% interest, the monthly payment (before taxes and insurance costs) equals $954.83. Take the same exact loan and decrease the mortgage term to 15 years, and the payment jumps to $1,479.38 – a difference of only $524.55 per month.
Determining Which Is Best for YouDeciding between a 15 0r 30 year mortgage is a major decision that will have long-lasting effects on your personal finances. Before settling on a term, consider your current financial situation and your long-term financial goals. For instance, if you plan to retire in the next 15 years and you wish to eliminate your mortgage before retiring, closely review your finances to see if your income can support higher payments. Take into consideration your other debts and household bills.
If you’re buying your first home, consider the amount of disposable income and personal savings you have. A 15-year mortgage can take a significant chunk of your income, and if you don’t have a lot of extra income or a significant savings account, it’s likely in your best interest to skip the shorter term and stick with a 30-year mortgage.
Also, the interest paid on a mortgage loan is tax deductible. Because 30-year mortgages involve higher interest payments, this type of mortgage may be a better fit for people who need additional write-offs. For instance, high earners, self-employed people, and independent contractors may all benefit from a long-term mortgage. Even if you’re an employee with a modest income, you can still take advantage of a 30-year mortgage to lower your tax liability.
Michael A. LiPari | NMLS: 187388 Bond Street Mortgage, LLC | NMLS: 191351
115 West Century Road Suite 115 Paramus, NJ 07652