When it comes to financing a home, the goal is to pay as little interest as possible. Opting for a 15-year fixed-rate mortgage helps in that respect because it will usually come with a lower interest rate than a 30-year option. However, a 15-year mortgage doesn’t work for every homeowner, as it also comes with higher monthly payments. How do you decide which one is right for you?
The pros and cons of a 15-year fixed-rate mortgage are relatively simple. As for pros, the interest rates are usually lower than those for a 30-year mortgage, which means you will pay less interest over the life of the loan, and the fixed-rate locks you into a regular monthly payment, making it easier to plan your budget. Having a loan with a shorter term also lets you build equity in your home more quickly and pay off your mortgage in half the time.
The downside of a shorter term mortgage is that, even with the lower interest rate, you will have a larger payment each month than you would with a 30-year fixed-rate mortgage. That is because the only way to pay the same amount of money back in half the time is with larger payments.
For example, imagine you arrange a 30-year fixed-rate mortgage of $250,000 at today’s average rate of 3.5 percent. Your monthly mortgage payment would be $1,122.61. If you paid that amount every month for 30 years, with no additional payments, you would end up paying $154,140.22 over the life of the loan.
If you were to instead choose a 15-year fixed-rate mortgage of $250,000, you might get a 2.75 percent interest rate. Using those numbers, your monthly mortgage payment would be $1,696.55. But when you paid off the loan in 15 years (without additional payments) you would only be paying $55,379.74 in total interest.
It’s easy to see why a 15-year fixed-rate mortgage is more attractive over the length of the loan. In the above examples, you would be saving nearly $100,000 over the life of the mortgage. Yet you would also need an additional $573.94 to cover the higher monthly payment.
If you plan to continue working for another 15 years, a 15-year fixed-rate mortgage may let you pay off the loan more quickly, and hopefully be mortgage-free by the time you reach retirement. If circumstances should change before the mortgage is paid, the greater equity in your home could give you more options for refinancing the remaining amount (if needed).
When planning your home financing, it is a good idea to get a Good Faith Estimate (GFE) for both 15-year and 30-year fixed-rate mortgage options. If the 15-year monthly payment is too expensive, you can opt for the 30-year option and can make extra payments towards the principal when you have the extra funds available. Otherwise, the 15-year mortgage may be well worth considering.