March 10th, 2011
15 Year vs. 30 Year: Which Mortgage Term is Best For You?
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**Today’s guest post is contributed by DoughRoller.**
If you’re trying to decide between a 15 year and 30 year fixed mortgage, there are many things to consider. Let’s take a look at the differences between the two types of mortgages, and then see how it might apply to a case study.
Differences between 15 year and 30 year fixed mortgage
Time period. The glaring difference between the two loans: one takes 30 years to finish paying, and the other takes only 15. That might seem an easily understood difference, but take a second to really consider what that difference can mean for your lifestyle. Making an informed decision requires some deep thinking about where you’ll be in 15 or 30 years.
If you’re a 30-year-old first time home-buyer, you’ll be making mortgage payments until you’re 60, or 45. Thinking about what you want to be doing at those stages of your life makes good sense for financial planning.
Interest rates. You might expect that payments on a 15 year mortgage to be twice as much, since you have half as much time to pay the principle back. Not so, because the two loan types differ in interest rates. 15 year mortgage borrowers can generally get a lower rate. For example, one bank may advertise 30 year fixed mortgages at 4.72%, while a 15 year mortgage can be obtained at 4.1%. Over the course of both loans, you’ll pay significantly less interest on a 15 year mortgage.
A 30 year mortgage spreads the principle over twice as much time. Because of this, and despite the higher interest rate, the 30 year mortgage will have significantly lower monthly payments. With a 30-year fixed mortgage, a potential homeowner can generally afford a higher mortgage.
Lifestyle. Again, the two vary in terms of lifestyle. In the long run, you’ll have more money to spend on other things if you go with a 30 year mortgage. In the short run, more of your monthly income will be tied up in higher mortgage payments with a 15 year mortgage.
A Case Study
Which mortgage option makes more sense for you? Let’s take a look, using the interest rates above.
On a $200,000 home, the 15 year term, 4.1% interest rate mortgage borrower will write a check for $1,489 every month. The 30 year term, 4.72% interest rate borrower will spend $1,040. Over the course of the loan, the 15 year mortgage borrower will spend $68,095 on interest. The 30 year borrower will spend $174,285, a difference of $106,190. Put another way, the 30 year borrower will spend over 2.5 times as much on interest.
Now is a good time for a note about taxes. Some well-intentioned people advocate for 30 year mortgages because, since you pay more interest, you are able to deduct more from your taxable income. That’s true as far as it goes, but you can only deduct more because you’re paying more in the first place. Let’s take the example above.
Even if you were in the bracket with the highest marginal rate (and thus able to save the most by deducting), you would save 35 cents in federal taxes for every dollar you pay in interest. The 15 year borrower would pay $44,261.75 in interest-less-tax-savings; the 30-year holder would pay $113,285.25. The difference is less, but the 30 year borrower is still paying over 2.5 times as much.
What’s Best For You?
Ask yourself if a higher monthly mortgage payment will put too much pressure on you, and in the case of a financial emergency, it would be difficult to make the payments. If that’s the case, you may be more comfortable with the lower payments.
Also, consider the lifestyle you want in the future. Having your mortgage paid off in full can offer a huge amount of financial freedom. If you’d like that freedom sooner than later, and can buckle down in the present to make higher payments, consider a 15 year mortgage.