Homebuyers should consider several characteristics when comparing different mortgage options, such as the reputation of prospective lenders and the interest rates associated with each loan. Additionally, it will be critical to consider the term length, a detail that some buyers overlook.
A mortgage’s term length represents the amount of time it will take to pay off a mortgage in full, assuming you keep making all of your monthly payments in full and on time. The most common term for a mortgage in the United States is 30 years. The second most common term length is 15 years, and while you can find mortgages with various other term lengths, they are not very common.
Ultimately, the term length you choose for your mortgage will affect various factors, such as your future monthly payments and the amount of money you end up paying in interest. While it will be possible to refinance your mortgage in the future if you change your mind, doing so can be somewhat expensive, so this is a decision you will want to take seriously.
This article will discuss the most important things to consider when choosing between a 15-year vs. 30-year mortgage, including how these contracts work and their pros and cons.
How Do Mortgages Work?
A mortgage is a specific class of loan issued by a mortgage lender that helps homebuyers finance the cost of a real estate purchase. Today, the two most common types of mortgages are 15-year mortgages and 30-year mortgages.
A mortgage will use the property itself as leverage, meaning that the mortgage lender can claim ownership of the property if the borrower stops making payments. Using leverage is why most borrowers can secure mortgages for a significantly lower interest rate than their other lines of credit (such as a credit card).
As mortgage owners continue making their monthly mortgage payments, their home equity share will continue to grow. To qualify for a mortgage, you will usually need to be able to validate a minimum income level and have the equity available to make a down payment.
What is the Difference Between a 15-Year and a 30-Year Mortgage?
As long as you can meet your lender’s corresponding income requirements, whether you choose to get a 15-year mortgage or a 30-year mortgage will be entirely up to you. Regardless of the type of mortgage you are considering, it is a good idea to consider multiple different lenders before making your final decision.
The main difference between a 15-year and a 30-year mortgage is the amount of time it takes to pay off the loan in full. Once you have made all of your mortgage payments (and paid off any outstanding fines), the title will transfer from your lender, and you will become the outright owner of your home.
With a 15-year mortgage, you will make 180 mortgage payments before owning your home, and with a 30-year mortgage, you will make 360 mortgage payments. Since it takes less time to pay off a 15-year mortgage, the size of each monthly payment will be considerably larger than that of a 30-year mortgage.
Contrary to what some people assume, the size of a 15-year mortgage payment is not double that of a 30-year alternative. It is usually only about 1.5 times the size of a 30-year payment, meaning that, in the end, the total cost of paying off a 15-year mortgage will be notably less. The borrower will only be subject to 15 years of interest rate charges rather than 30 years.
Both types of mortgages can be appealing, depending on your personal financial circumstances.
Benefits of a 30-Year Mortgage
The most obvious benefit of a 30-year mortgage is that your monthly payment will be significantly lower. Due to the extended period of time you have to pay off your mortgage in full, you will not have to make nearly as large of a payment every month.
Suppose you are applying for a $300,000 mortgage and secure a six percent interest rate. Using the RealtyHop Mortgage Calculator, you can see that with a 30-year term and no down payment, your monthly payment will amount to $1,799. However, with a 15-year fixed-rate mortgage, your monthly payment jumps up to $2,532.
That difference is $733 per month, or about $9,000 per year. For many homeowners, that might be the cutoff between whether a given home is affordable or whether that home is too expensive.
Using a 30-year mortgage allows you to afford a considerably larger home without needing to modify your budget. For example, suppose you know that the most you can spend on your monthly mortgage payment is $2,000. With a 30-year mortgage with a six percent interest rate, you could afford a home worth up to $334,000. However, if you had a 15-year mortgage with the same interest rate, you’d only be able to afford a home worth $237,000.
These are not minor differences. For both experienced and first-time homebuyers alike, the 30-year mortgage is considerably more manageable, which is why it is currently the most popular mortgage in the United States (and many other countries, as well).
Benefits of a 15-Year Mortgage
One reason people will choose a 15-year mortgage is that, in many situations, 15-year mortgages offer slightly lower interest rates. Typically, the rate gap between these loans will be around 1 percent (or slightly less).
Additionally, because it takes less time to pay off the loan, 15-year mortgages can help you save a substantial amount of money in interest payments. Using our previous example of a $300,000 mortgage with no down payment and a six percent interest rate, it is easy to highlight the benefit of this lower amount of interest.
If you take 30 years to pay down this loan (with a monthly payment of $1,799), you will pay $648,000 over time. That means that by the time you own your home, you will have paid more in interest payments than you did in principal payments.
On the other hand, while the monthly payment for this property with a 15-year term will be $2,532, the total amount you’ll end up paying between the principal and interest is just $456,000. That’s a total savings of $192,000.
Which Mortgage is Right for Me?
Many homebuyers select a 30-year mortgage due to the lower monthly payments, which provide financial flexibility. If you sign on for this longer term and increase your cash flow down the line, you can always refinance to secure a new monthly payment amount and pay off your mortgage in a faster timeline.
Homebuyers with a more considerable income who wish to purchase a property below their budget may find a 15-year term appropriate. Buyers can save money in the long run by paying larger amounts monthly due to fewer payments and a lower interest amount. Shorter loan terms also offer lower interest rates, allowing buyers to save even further.
No matter the type of mortgage term you decide to pursue, it is important to shop around with various lenders to ensure you find the best interest rate. Consider your interest rate, loan term, and the amount you can put toward a down payment to find the best financing solution for your home buying needs.