March 23, 2017
Most homebuyers choose a 30-year fixed rate mortgage. There’s nothing wrong with going the conventional route and spreading your payments over 30 years. But I wish more people would take out a 15-year mortgage instead.
Let’s run through the advantages of a shorter-term loan. For starters, the interest rate is lower. Recently the average rate for a 30-year fixed rate was 4.3%, while a 15-year has an average fixed rate of just 3.5%. That’s nearly a percentage point less!
Because of the lower interest rate and the shorter payback period, you owe a lot less interest on a 15 year, over the life of the loan. For example, let’s say you borrow $250,000. If you pay that back over 30 years at a fixed 4.3% interest rate you will owe a total of more than $195,000 in interest. If you pay that back over 15 years at the current fixed rate of 3.5% your total interest payments will be around $72,000. Big difference, right?
Now let’s talk about the one drawback. Paying back a loan in 15 years rather than 30 years means the monthly payment will be higher. Using the $250,000 loan example again, the difference in monthly payments is $1,237 v. $1,787. I realize $500 a month is not trivial, but don’t forget what the payoff is: you are out of debt so much faster and save more than $100,000 in interest payments. I realize there may not be one line item in your budget that can be cut to save you $500. But if you make it a priority to find savings, I bet you can find 10 line items that can each be cut by $50 a month.
Another option is to reduce the price tag for homes you are shopping for. By shopping for a less expensive home you will be better able to afford the 15-year mortgage. For example, if you borrow $180,000 on a 15-year, the monthly payment is close to what you would owe on a $250,000 loan you pay back over 30 years. You know one of my most heartfelt beliefs is “Live Below Your Means, but Within Your Needs.” I bet the less expensive home can meet your needs. And by being able to finance it with a 15-year mortgage you are setting yourself up for a much more secure financial future. Just think of the freedom that will come from knowing you are out of mortgage debt in half the time!
Now if you already have a 30-year and wish you had a 15-year, you still have a great option. You can make additional payments on your existing loan and get it paid off faster. Contact your current lender and ask them to send you an amortization schedule for what your monthly (or annual) extra principal payments would need to be to get the loan paid off in 10 years, or 15 years, or whatever your target is. Or you can figure it out with an online calculator.