30 Year vs 15 Year Mortgage – Which is Better?
You’re ready to buy a home but face a big decision. You’re looking at a 30 year vs 15 year mortgage – how do you decide?
What is the Difference between a 30 Year vs 15-year Mortgage?
First, there’s the obvious difference – the length of time it takes to pay off the loan. A 30-year loan takes 30 years to pay off and a 15-year loan takes 15 years. Beyond the term, there are a few other differences:
- You pay more principal with each mortgage payment on a 15-year loan since you have less time to pay it off in full
- 15-year loans typically have lower interest rates because you borrow the money for less time.
- You pay less interest over the life of the loan since you pay the loan off faster.
- You build equity faster with a 15-year term because you pay more principal down each month.
Is the 15-Year Term Better than the 30-Year Term?
The 15-year term has a lot of benefits, especially the lower amount of interest you’ll pay. But it isn’t always better than the 30-year term. Here’s why.
- The 15-year loan has higher monthly payments. Not everyone can afford a higher payment because it makes it hard to afford the other costs of living.
- It’s harder to qualify for the 15-year term. You must prove you can afford the higher payment by proving that your debt-to-income ratio is in line with the loan program. The higher mortgage payment may put you over the DTI threshold.
- You are on the hook for the higher payment. On a 30-year mortgage you can always make additional payments. If you can’t or don’t, there’s no penalty. With the 15-year term, though, you are obligated to make the higher payment. If you don’t, you put your home at risk of foreclosure.
Why a 30-Year Fixed Loan may be Best
Every borrower has different reasons and capabilities for taking on a loan, but sometimes, the 30-year loan just makes more sense because it offers:
- Lower monthly payments – If you are unsure about affording the 15-year payments long-term, opt for the lower 30-year payments and pay extra when you can.
- Larger tax savings – If you qualify to itemize your tax deductions (your deductions are more than the standard deduction), you can write off the higher interest payments you make on the 30-year term.
- You aren’t in a hurry to sell your home – If this is your long-term home, you aren’t in a rush to have a large amount of equity and have time to pay it off slowly and as you are able to afford.
The Bottom Line: 30 year vs 15 year mortgage:
A 15 year mortgage is the better way to go. Just as an example, the total interest you would pay on a $400,000 loan for a 30 years mortgage at 2.60% APR is approximately $176,489. Interest payments on a 15 year mortgage at 2.25% APR. would be approximately $71,661. That is a huge savings of $104,828!
However, if you sign up for a 15 year term it should not be a stretch for you financially in that you have more than enough income to pay the higher monthly payment and money in the bank if something happens. If living through 2020 has taught us anything it’s that things can change quickly and unexpectedly. One can always make extra payments on a 30 year loan. You will be stuck with the higher payment on a 15 year loan. In the example above the 30 year loan has a payment of around $1601 while the 15 year loan would have a payment of around $2620. That’s a big difference. If you and your spouse both work and you need both incomes to cover the higher payment then a 15 year loan term is probably not for you! Take the 30 year loan and pay extra on the principal each month.
A better strategy? Invest the difference
There’s another school of thought that says: Rather than paying extra on your note, in this case almost $1,000 extra each month, take the difference and invest it. Let’s say you can earn a 5% rate of return you are coming out ahead financially. On a 30 year note after 15 years of putting $1,000 + aside each month you’ll have $180,000 in the bank plus compounded interest! Not a bad way to go.
When you’re looking at a 30 year vs 15 year mortgage, you have a lot to consider. While the 15-year mortgage sounds better because you own the home much faster, there is a lot to consider before committing to the shorter loan.
Run your own scenarios: Use our handy mortgage calculator to see what your monthly payments will be. Be sure to compare the total interest paid on both loan terms!