Buying a home is usually the largest investment that you will make in your life, and choosing the right financing can have a significant effect on your overall financial profile. Many home buyers wonder whether a 15- or 30-year mortgage is the better option for their financing needs, with the majority opting for a 30-year plan. From a strictly dollar and cents perspective, the 15-year is always the right choice. You will likely receive a lower interest rate due to the shorter term, and you will pay less than half the amount of interest associated with a comparable 30-year mortgage.
Another boon of choosing the 15-year is that there are typically no penalties (i.e., higher interest rates) or requirements of a higher down payment if your credit score is less than stellar or you would like to make a lower down payment. These are referred to as Loan Level Price Adjustments and are typically not implemented with 15-year loans. Banks offer more favorable interest rates for 15-year mortgages because they prefer the shorter term as they receive their money back in half the time. In fact, due to the faster amortization of the 15-year loan, it takes more than twice as long to pay off a 30-year mortgage than its 15-year counterpart.
With the significant savings that one is able to realize with a shorter term, why does the 30-year mortgage remain the most popular financing vehicle for home ownership? The main reason why home buyers forego the 15-year mortgage is affordability. The monthly payments can be as much as 50% more than those for the same amount taken in a 30-year mortgage. By paying down your mortgage more quickly, the higher payments help you to build equity at a faster rate, and many consider these higher payments a forced savings.
For example, if a $300,000 mortgage may be available at 4% for 30 years, or at 3.25% over 15 years. You will now be saving due to the compressed amortization as well as the lower interest rate. The actual difference in interest paid is astounding: $215,609 in interest for the 30-year option and a jaw dropping $79,441 if you opt for the 15-year mortgage. It does all come at a price, of course. The monthly payments for the 30-year mortgage are $1,432 which is almost 50% less than the 15-year payment of $2,108.
It is definitely worth the belt tightening that may be necessary to swing the higher monthly payments, as the potential savings are more than significant. The equity in your home will serve as savings, and you will appreciate not having a mortgage payment once you are on a fixed income in retirement. There is strong evidence to support a 15-year mortgage as the better option in the long run, and if you can manage the higher monthly payments, it is definitely the way to go. Owning a home can be your largest expense as well as your greatest asset, and the less interest that you pay during your mortgage, the better your investment.