One of the epic battles in the world of personal finance is that over the best mortgage length. When applying for a mortgage, there two primary fixed rate options: 30 year fixed and 15 year fixed.
There are pros and cons to each mortgage length, and it’s important that you carefully consider the ramifications involved before you sign on the dotted line.
Shorter Term = Less Paid Overall
The biggest advantage to the 15 year fixed mortgage is the fact that you pay less over the life of your loan. First of all, the mortgage term is shorter, so you aren’t paying for as many years, and this means less paid in interest.
This reality is further enhanced by the fact that most 15 year mortgage terms come with lower interest rates. You might see a rate that is between 1 percent and 1.5 percent lower when you decide on a 15 year mortgage length. Over the course of time, this can save you tens of thousands of dollars over a 30 year mortgage term with a higher interest rate.
Here is an example of how it works: Say you borrow $175,000 for your home. A 30 year mortgage is at 4.20 percent and a 15 year fixed is at 2.90 percent. Your 30 year mortgage will end up costing you $133,080.22 in interest — on top of the $175,000 you borrowed. By contrast, the 15 year fixed loan costs $41,021.44 in interest. That’s difference of just over $92,000 saved on your mortgage.
If your main goal is to save money over the course of your mortgage loan, the 15 year fixed mortgage is the way to go. But before you decide that this is a better home loan option, consider the ramifications of a 15 year loan.
Higher Payments and Less Flexibility
In terms of sheer numbers and money saved, the 15 year fixed is going to offer an advantage over the 30 year fixed. Where the 15 year term impacts you is in the monthly cash flow. Since you have the same size of mortgage, and you are cramming it into half the mortgage length, your monthly payment is going to be higher — even if your interest rate is a little lower on the 15 year version.
If you are stretching to make your mortgage payment, this can present a problem. If your finances take an unexpected hit, you could end up struggling to make your higher payment. With a 30 year mortgage, you have a lower monthly payment, which can benefit your current cash flow situation. While it might be tempting to go with the 15 year loan, the reality is that you might end up in worse shape if an unexpected money emergency results in an inability to make your payments.
Using the example above, your payment with a 15 year loan would be $1,200.12 per month, while your payment with the 30 year loan would be $855.78. Even though you are saving more over time, you are paying $344.34 more each month. Can you afford that with ease? Or would the smallest financial setback make it difficult to pay that extra amount each month?
For some people, the 30 year fixed, and the lower payment that comes with it, makes more sense. If your primary concern is present financial security and cash flow, the 30 year loan is better than the 15 year loan.
Taking Advantage of Both Fixed Rate Worlds
Many borrowers use an interesting tactic to combine the advantages of both mortgage lengths. They choose the 30 year fixed rate mortgage, but make an extra payment each month so that the amount paid is in line with the 15 year fixed rate mortgage. That way, they pay off the loan faster, saving on interest, but still have the flexibility to scale back on monthly mortgage payments if there is a financial rough patch.
As you can see, it’s important to consider you entire situation so you can pick the best mortgage length for you.