The term of a mortgage, whether it be 15 years or 30 years, largely determines its structure and cost. While 30-year mortgages are popular for their smaller monthly payments, it's the 15-year mortgage that promises lower costs in the long run.
The 30-year fixed-rate mortgage is a financial staple in American households, often serving as a pathway to first-time homeownership. However, 15-year mortgages could offer more monetary savings over time even if they necessitate higher monthly payments.
The structure of a mortgage resembles a term loan, secured by real property. The interest and principal parts of the fixed monthly payments start huge and gradually decrease over time, respectively.
The shorter duration of a 15-year loan hikes up the monthly payment but proves cheaper on a rounded scale. In the lifespan of a loan, a 30-year mortgage could be more than twice as expensive as a 15-year deal. This is because longer-term loans bear more risk and cost for banks, hence a higher interest rate for a 30-year loan.
In the context of a 15-year vs. 30-year loans, the high-interest rate in the latter results in slow reduction of principal balance, significantly increasing long-term borrowing costs.
James Morin, senior vice president of retail lending at Norcom Mortgage in Avon, Conn, highlights another key difference: “Some of the loan-level price adjustments that exist on a 30-year do not exist on a 15-year, making 30-year mortgages more expensive."
With a hypothetical $300,000 loan calculated at 4% for 30 years or at 3.25% for 15 years, borrowing for a shorter term could save two-thirds of the total cost. However, this cost-saving measure requires higher monthly payments.
Financial experts often view a 15-year mortgage as an enforced savings plan via home equity. If an investor's income stream allows higher payments, they should opt for the 15-year plan. Short-term mortgages can also be beneficial for those approaching retirement and expecting a fixed income.
The incentives for investing elsewhere, like a 529 account or 401(k) plan, could make a 30-year mortgage seem more appealing. This move, however, carries inherent risks, warns Shashin Shah, a certified financial planner based in Dallas, Texas. Resilience to market volatility and commitment to systematic investment of monthly saving differentials are key.
Private mortgage insurance is another factor, and it is likely required by lenders if a down payment is less than 20% of the property value.
If the higher payments required by a 15-year mortgage seem unaffordable, one could capture the savings of this term by making larger payments on a longer loan, assuming no prepayment penalties exist.
The choice between a 30-year and a 15-year mortgage depends greatly on individual circumstances, including monthly payment affordability, interest in long-term savings, and financial flexibility. Extra payments on principle can help to pay down a 30-year loan faster, giving a taste of a shorter term without complete commitment.
Refinancing to a 15-year mortgage from a 30-year loan could be considered. One needs to be aware of the higher monthly payments and compare the existing interest rate with potential new rates. Factor in the costs of the new loan including origination fees, closing costs, and other expenses before deciding if it's worth it.
Deciding between a 15-year and a 30-year mortgage is not a task to be taken lightly. Carefully weigh your options, assess your short and long-term financial goals before picking a mortgage term that syncs well with your financial roadmap.