The majority of American home buyers sign up for 30-year fixed-rate mortgages (FRMs) – the staples of mortgage lending. And yet there is another option that may serve many borrowers better: the 15-year fixed-rate mortgage. Both loans include an interest rate that does not change over the course of the loan but one is paid off twice as fast as the other. Both can be financially savvy in certain situations.
If you are looking for the lowest monthly payment, a 30-year FRM beats the 15-year. That is because the loan principal balance is paid off twice as slowly than the 15-year, dividing those payments almost in half. Having lower monthly payments can be especially helpful for qualifying for a more expensive home. Lower payments may also appeal to you if you need to hold on to more of your money for financial goals like college tuition or retirement savings.
Interest rates are lower, however, on 15-year FRMs. That is because shorter loans are less risky to lenders than longer ones and they cost less money to originate. The interest rate on a 15-year FRM can be anywhere from 0.25% to 1.0% lower than on a 30-year FRM.
Total interest costs on a 30-year FRM will be dramatically higher than for a 15-year FRM. This results from the fact that the interest payments are front-loaded on both loans and the 30-year FRM requires so much longer to pay down the interest. And the higher the interest rate on the loan, the larger the difference in total interest charges over the life of the loan.
Here’s an example of the gap in costs: Let’s say you need a $300,000 mortgage. With a 30-year FRM, you get a 4.5% interest rate and your monthly mortgage payment would be $1,520.06. With a 15-year FRM, your interest rate might be more like 4% with a monthly payment of $2,219.06. Over the course of those loans, you would pay $247,218 and $99,432 respectively in interest charges. The 15-year FRM would save you $147,787 over the course of your loan over the 30-year FRM, but you would have to be willing and able to pay an extra $699 each month.
And sometimes the benefits of keeping that money in your pocket each month outweigh the overall interest savings. A 30-year mortgage can be better if you do not plan to stay in your home very long. The lower monthly payments could help you save up a bigger down payment for your next house. A 15-year FRM is often a great choice for those who want to stay put long-term or for those who have already met important financial goals and are ready to pay off their mortgage quicker. It can also be beneficial for those who are close to retirement. Having the house paid off before retirement can be a huge relief for those living on a fixed income.
If you still have questions about which mortgage choice is best for you, give us a call at Island Home Capital, Inc. at 808-326-2444 to discuss whether a 15-year FRM or a 30-year FRM will better serve your fiscal needs.