If you plan to purchase a house, you need to plan on taking out a mortgage. For the vast majority of Americans, these two things go hand-in-hand.
Houses simply cost too much to finance on your own.
By taking out a mortgage, you get the money you need to pay for your house and then pay that loan off over time.
Usually, this means paying it off over 15 or 30 years.
This may seem like a straightforward decision, but it’s one that actually involves a number of factors. Given how important a mortgage is to your future happiness, then, it’s essential that you understand this choice in detail.
15-Year Mortgages Come with Lower Interest Rates
If all you cared about were interest rates, the 15-year mortgage would win this contest, hands-down.
This makes sense when you think about it. There’s less risk for a bank to issue a 15-year mortgage because they stand to recoup their money twice as fast as they would with a 30-year mortgage.
Once they get that money back, they can reissue it again for another mortgage, too. This is one more reason banks charge less for 15-year mortgages.
30-Year Mortgages Have Lower Monthly Payments
Now, for many people, a lower interest rate simply isn’t worth it because they come with much higher monthly payments.
Again, this makes perfect sense.
Setting interest rates aside, if you have 15 years to pay back $100,000, your monthly payments will need to be twice as much as if you had 30 years.
This is why most people choose 30-year mortgages. It’s much easier on their budgets, which leaves them more options for making purchases and investing.
15-Year Mortgages Cost Significantly Less
Paying less interest really, really adds up.
For example, let’s say you buy a house for $160,000 and have a marginal tax rate of 25%. Interest rates change, but for the sake of this hypothetical, they’re 5% for a 15-year loan and 4.5% for the 30-year version.
That half-a-percent difference may not seem like enough to justify those higher monthly payments, making the 30-year loan pretty attractive.
Yet, when you do the math, you find that the 30-year mortgage will cost the homeowner $149,211 on top of their initial loan. That’s a total of $309,211 for the home – almost twice as much as the amount they borrowed.
For the 15-year loan, the total interest comes to $60,318 for a total of $220,318. That saves the homeowner $88,893 – no small sum.
So while paying less a month may seem like a no-brainer, remember how much it’s costing you in the long run.
Choosing a 30-Year Mortgage and Paying It Off Early
It may have already occurred to you that you could have the best of both worlds by taking out a 30-year mortgage and paying it off early. You could make two payments a month and, if you hit a rough streak, just go back to making the bare minimum until you recover.
Using the numbers from our previous hypothetical, your total interest payments would equal $67,749. Adding that to the initial sum you have to pay back gives you $227,749.
That would save you $81,462 compared to paying your 30-year loan off on time, but only cost $7,431 more than the 15-year mortgage.
Maintaining the discipline to do this will definitely be a challenge. However, as you can see, the benefits are worth it.
Unique Factors You Need to Consider Before Taking Out a Mortgage
For a lot of people, this is where the decision-making process ends. They look at these factors and choose their mortgage based on the one they prefer more.
However, it’s worth thinking about several other factors that should affect your decision.
The Health of Your Personal Finances at the Moment
Many homebuyers just don’t have the income to pay off a 15-year mortgage. After all, it could easily be several hundred dollars more every single month.
Your personal finances must be taken into consideration before you choose a mortgage and this has to involve more than just your salary. You also need to consider your:
- Retirement Planning
- Emergency Fund
Will a higher monthly payment have a negative impact on these financial priorities?
Keep in mind, too, that the money you save every month could come in handy for a number of reasons.
You might come across an attractive investment opportunity. Maybe you’ll want to start a side business at some point or purchase a cabin.
With a 15-year mortgage, there’s going to be far less wiggle room, which is why you need to take a long, hard look at your personal finances before committing.
The Forecast for Your Job Security
You’ve probably heard a horror story or two about someone who took out a mortgage and, shortly thereafter, lost their job.
It’s not a pleasant thought, but it’s an essential one.
Before you take out a mortgage, much less decide between your two options, think about where you are in your career and how stable your job is.
This can be an eye-opening and even difficult process. You may find that now isn’t such a good time to take on this kind of financial responsibility.
Better to put the decision off than find out you made a mistake long after the ink has dried on a mortgage.
Your Level Risk Tolerance
That provides a perfect segue into talking about a very personal factor that plays a role in the vast majority of your financial decisions.
Everyone’s risk tolerance is different and there’s no way of measuring whether yours is good or not, other than to look back at past financial decisions. If they tend to end badly, maybe you should take on less risk. If you’ve never had any problems, taking a little more risk may actually be good for your finances.
At the end of the day, if you have a low risk tolerance, the aforementioned benefits of a 15-year mortgage won’t be worth it. You’ll spend your nights tossing and turning as you worry about next month’s payment.
Likewise, if you’re comfortable with more risk, you’ll end up kicking yourself for taking a 30-year mortgage when you could own your home in half the time. Even if you pay it off early, as we talked about earlier, the interest rates will still add significantly more to the total.
This is another very personal metric, but here are some questions you should answer to assess your future financial requirements:
- Do you plan to have kids (or more kids)?
- Do you want to buy a second home?
- Will you help with your child’s college expenses?
- What is your health and that of your family’s like?
There are probably plenty of other factors to think about unique to your situation, too. As we mentioned before, a mortgage of any kind is going to tie up your finances for the foreseeable future. To what degree you can tolerate this will depend, in large part, on what your long-term goals are.
Taxes Should Not Be a Major Factor
To put it simply, your tax incentives will be better if you go with a 30-year mortgage. The reason we didn’t list this as a major benefit above is because it’s not. It’s a very minor benefit and one that is so small it shouldn’t weigh on your decision one way or the other. Everything else we’ve covered in this piece is far more important.
There’s no one-size-fits-all advice that we can give when it comes to the right mortgage. While 30-year mortgages are definitely the most popular option, that doesn’t necessarily mean it will be right for you.
Instead, take time to consider each of the above points. Using a mortgage calculator may help, too.
Taking out a mortgage is going to be a big decision no matter what, but that doesn’t mean it needs to become an intrusive burden. Use the above advice to make sure the mortgage you choose will fit your lifestyle and support your happiness. It’s up to you to help in this 15 year vs. 30 year mortgage competition. Which do you like better