30 Year loan
When you're buying a house, it is tempting to buy as much as house as you possibly can. Because of this, more often than not people sign up for a 30-year mortgage. A longer mortgage term means lower payments and the option to buy more house than one might qualify for with a 15-year mortgage.
While there is nothing inherently wrong with a 30-year mortgage, it does mean that one will pay significantly more interest on a 30-year loan than they would if they had a 15-year mortgage due to the much extended loan term.
This doesn't mean that a 15-year mortgage is right for everyone, but it does make the option worth exploring. If one has a full understanding of the differences between the two products, they can presumably make a more informed decision about which loan option is better for them.
The 30-year mortgage
The 30-year mortgage is one of the most popular options when it comes to borrowing money to buy a home. I think the most appealing part of a 30-year mortgage is the fact that you can get a lower monthly payment and be able to afford more house than you could with a shorter-term loan.
However, a bigger house is not always what it seems to be. Something to consider when buying a bigger house is that it costs more to maintain. So even though your mortgage payment is smaller when you buy a bigger home on a 30-year note, you will pay more in property taxes and more for monthly maintenance of that home. For that reason it’s important to factor those considerations in to the equation when purchasing a home.
Also, a bigger home often means bigger repair bills and more time spent for keeping up the home. There are more windows to wash, more floors to vacuum and more walls to paint. A bigger home not only means more money, but more time as well.
For this reason it’s important not to fall for the allure of a bigger home simply because the payments on a 30-year mortgage for that home are affordable for your budget. Consider all of the costs of owning a larger home before choosing a longer mortgage term simply for the sake of buying up.
A 15-year mortgage
The 15-year mortgage is not as popular as the 30-year mortgage, primarily because your monthly payment is significantly higher than on a 30-year mortgage. Also, we live in the age of “how big of a payment can I afford?” While the payment amount should be affordable, it shouldn’t be the only determining factor of a purchase – especially one of the largest you’ll make such as a home.
What most people fail to realize is that choosing a 15-year mortgage term over a 30-year mortgage term results in a long-term monetary savings benefit that can easily run in the tens of thousands of dollars. For example, look at this chart from BankRate.com. The chart compares the payment differences and the interest paid differences if you were to borrow $250, 000 for a home.
|Your costs for a $250K fixed rate mortgage||15 year at 4.5%||30 year at 5%|
|Your monthly payment||$1, 912||$1, 342|
|Interest you'll pay during first five years||$49, 283||$60, 095|
|Interest you'll pay over full term of mortgage||$94, 247||$233, 139|
The difference in the interest you’d pay if you chose a 30-year mortgage instead of a 15-year mortgage is $138, 892. That’s a lot of cash!
This is where the factor of opportunity cost comes in. If you were to take that $138, 000+ and invest it over 15 years at a 7% rate of return, you’d have an investment account worth over $383, 000! That’s not chump change by any means. Choosing to pay less interest on your mortgage and invest the money you’ve saved by forgoing a 30-year mortgage is a much better choice from a purely financial standpoint.
Don’t forget about PMI
PMI, an abbreviation for Private Mortgage Insurance, is another additional cost factor to consider when buying a home. Government mortgage lending guidelines dictate that if a buyer doesn’t put at least 20% down on a home purchase, they are required to purchase PMI for the mortgage. Private mortgage insurance guarantees the loan will be paid in full by the insurance company if a borrower defaults on the home loan.
PMI can easily run $150-$200 a month in addition to your mortgage payment, homeowners insurance and tax costs. For that reason it’s important to consider waiting to purchase a home until you have at least enough money saved to put 20% down payment on the house plus covering the closing costs in cash.
Putting 20% down on a home also means you’ll have to borrow less money to have the home, resulting in a lower mortgage payment and making it easier to afford the payments on a 15-year loan term instead of a 30-year loan term.
What mortgage term is best for you?
Again, this isn’t to say that a 30-year mortgage term is always a bad choice. However, it’s important for borrowers to understand exactly how much they’re paying when they choose a mortgage term.
Once a borrower has a thorough understanding of the long-term costs of a 15 vs. a 30-year mortgage, and a thorough understanding of the full costs of home ownership in general, they can make a more informed home-buying decision.
A smart home purchase decision is about more than just the affordability of the payment; it means taking into consideration the total cost of the home. That includes interest payments, maintenance costs, time factors and a host of other considerations.