Buyers soon discover they’ve got more than a few decisions to make when first embarking on a new home purchase. One such consideration is your mortgage. And there are more than a few choices there, too. Homeowners may find themselves asking; Should I get a fixed rate loan or an adjustable? Should I lock in my interest rate or wait? Should I get a 15 year mortgage, 20, or 30? Let’s take a closer look.
Should I Get a 15 Year Mortgage? 6 Things to Consider
1. Interest Rates
When deciding whether you should get a 15 year mortgage, or a longer loan term, the first thing to consider is interest rates. The rates for 15 year loans are lower than those of 30 year terms. Depending on market conditions, a 15 year term might be as much as 1.00% lower than the 30 year companion.
2. Payment Amount
With a lower interest rate, it’s an easy choice, right? Maybe. But it’s not always just about the rate. The term of a loan may be more important than you might think. When you squeeze the payoff period in half from 30 year to 15, the monthly payments for the shorter term must be higher to compensate for the shorter term.
For example, let’s take a sample 30 year rate of 4.25% on a $300,000 loan amount. The principal and interest payment works out to $1,475 per month. Now apply a 15 year term to the same loan amount and a 3.75% rate. The payment is now $2,181. That’s a rather dramatic difference.
3. Total Interest Paid
Okay, so you’re probably wondering, why should I get a 15 year mortgage if the monthly payment is so much higher? It’s also important to consider the amount of interest paid over the life of the loan.
Let’s dig a little deeper using this same scenario. Over the course of a 30 year mortgage, the amount of interest paid is just under $292,000. Compare that to a 15 year term with the same $300,000 loan and the amount of interest paid is $92,700. Now you see why some borrowers choose the shorter term.
In short, though your monthly payments are higher with a 15 year mortgage, you end up paying less in total.
4. Building Equity
Another benefit of a shorter term is your ability to build equity faster compared to a longer term loan. Looking down the road after, say, seven years, the principal balance for the 30 year term is $259,646. The 15 year term? $180,701. Because the longer term carries so much initial interest, less is paid to the outstanding loan balance and more toward interest. This is another important reason homeowners may get a 15 year loan.
5. Loan Requirements
Do you need more income to get a 15 year loan? Technically yes, but the requirements are not any more strict for a 15 year loan than a 30 year loan. The difference comes down to the loan amount.
The monthly payments are higher with a 15 year loan, but lenders apply the same debt ratio standards, regardless of the term of the loan. In general, lenders like to see principal, interest, taxes and insurance payments be somewhere close to one-third of gross monthly income. That means you’ll qualify for a lower loan amount with a 15 year term compared to the 30 year because the 30 year makes the mortgage more affordable. So, you can borrow more with a 30 year loan compared to a 15 year term
6. Another Option
However, there is also an “in between” choice. You can take out a 30 year loan and make payments as if you have a 15 year term. What’s the point of doing that? It gives you some flexibility. Loans today do not have any prepayment penalty, so paying extra on the mortgage means the extra goes directly to the outstanding loan balance, and not toward interest. Let’s say you take out a 30 year loan and begin making a $2,181 monthly payment instead of the required $1,475. Each and every month that loan balance is gradually being drawn down.
Now let’s say an emergency comes up, such as a major automobile repair. Instead of tapping into your savings account to make the repairs or charging the repairs on your credit card, you can simply stop paying at the 15 year rate for a month or two and revert back to the 30 year term, using the extra cash to take care of the repairs.
If you think a 15 year mortgage is right for you, you should speak directly with a loan officer. A loan officer will help you compare monthly payments, interest paid in the short and long term, and how soon your mortgage will be retired.