You can save plenty in interest payments by taking out a 15-year fixed-rate loan instead of a loan with a longer term, such as a 30-year fixed-rate loan. But that doesn't mean that a 15-year loan, or any shorter-term loan, is necessarily the right choice for you.

The 15-year fixed-rate loan does come with lower interest rates and will save you money in the long-term. But it also comes with higher monthly payments because of its shorter payback period. And when you take out a 15-year loan, you are committing to those higher payments, no matter what changes hit your household budget.

Because of this, mortgage pros recommend that you think carefully before taking out a shorter-term loan.

"You need to consider your budget. You need to consider the home that you want to buy," said Matthew Hurst, assistant professor of finance at the School of Business Administration at Stetson University in DeLand, Florida. "You need to consider your investment habits and your tax rate. It all plays a role."

The benefits

It's important to first consider the benefits that come with a shorter-term mortgage. Say you take out a 15-year fixed-rate mortgage loan of $200,000 with an interest rate of 3.07 percent, the same rate that the Freddie Mac Primary Mortgage Market Survey said was the average for this loan type as of Oct. 1. You'd pay $26,529 in interest during the first five years of your loan and $49,823 in interest if you took the full 15 years to pay off what you borrowed.

If you took out a 30-year fixed-rate mortgage with an interest rate of 3.85 percent -- again the average for this loan type according to Freddie Mac as of Oct. 1 -- you'd pay $36,710 in interest during the first five years of your loan and $137,542 in interest if you took the entire 30 years to pay off your debt.

That's a lot of savings in interest. But there are drawbacks to a 15-year loan, despite these savings.

No flexibility

That same 15-year fixed-rate mortgage would leave you with a monthly payment -- not including taxes or insurance -- of $1,388. But if you took out the 30-year version, your monthly payment, not including insurance or taxes, would be $938. That's a $450 difference each month.

For many homeowners, the payments that come with a 15-year loan are simply too high.

"You are committed to locking in that higher payment," said Whitney Fite, president and founder of Atlanta's Angel Oak Home Loans. "Usually, it means that your monthly expenses are about 28 percent higher when you go with a 15-year mortgage instead of a 30-year one."

Fite said that 30-year mortgage loans come with more flexibility. They come with that lower monthly payment, of course. But there is nothing to stop homeowners from making a higher payment to their mortgage companies during those months when they do have extra dollars. During months when the finances are tighter, homeowners can simply make the regular lower payment.

With 15-year loans, homeowners don't have that option.

"The 15-year loan is a forced savings account," Fite said. "You are committed to it. You don't have the option to make a lower payment when you don't get as much money during a month as you expected."

For this reason, 15-year fixed-rate loans are often better choices for homeowners who receive the same monthly salaries each month, Fite said. Those who rely heavily on bonuses and commission checks are usually better off with the flexibility and lower payments that come with 30-year loans, Fite said.

A smaller house?

A 15-year loan can also make it more difficult for some buyers to get into a larger home in a more desirable neighborhood.

Hurst gives this example: Say you find a $300,000 home. If you use a 30-year fixed-rate loan to finance that property, your monthly payment will be about $400 to $500 lower -- depending on interest rates -- than if you took out a 15-year fixed-rate loan to finance that same house.

Buyers might not be able to get into their dream homes, then, if they are determined to take out a 15-year loan instead of one with a longer term.

"Are you able to get the house that you want?" Hurst asked. "Depending on where you want to live, you might only be able to get that right home with a mortgage that comes with a longer term."

A better use for that money?

Mortgages are some of the lowest-cost debt that consumers can carry, thanks to the low interest rates that come with home loans.

That's why Fite recommends that homeowners who are disciplined enough take out a longer-term mortgage loan and invest the extra money from a lower home-loan payment into stocks, bonds or some other type of investment.

"If you take those savings and invest them systematically on a monthly basis, you should assume some return over time," Fite said. "That might be a better play for some people depending on how long they are in their homes."

It's important, though, for homeowners to recognize their limitations when it comes to investing money. Not every homeowner who takes out a 30-year mortgage will invest their savings, even if they could afford to.

"Not everyone has the discipline that it takes to invest on a regular basis," said Paul Jacobs, a certified financial planner and chief investment officer with Palisades Hudson Financial Group's Atlanta office. "Some people will simply spend that extra money. They won't invest it or save it. For those people, if they can afford the shorter-term loan, it make more sense to go with the 15-year mortgage."

You plan to stay put

The biggest amount of interest savings with a 15-year loan come in the first five to 10 years, Hurst said. Those owners who plan on living in a home for a short time -- maybe they plan to move in five or seven years -- might do better to take out a 15-year loan, Hurst said. They'll enjoy big savings in interest and they'll pay down more of their mortgage. Owing less on a mortgage helps when it's time to sell.

But those owners who plan to stay put for more than 10 years? It might make more sense for them to take out the longer-term mortgage and then find some other use for the $500 or so they might be saving each month with a 30-year loan.

Lower tax savings

The interest that you pay on your mortgage is tax deductible. For many homeowners, this results in a significant amount of tax savings, especially early in their loans, when they are paying the greatest amount of interest.

If you are paying off a $200,000 30-year fixed-rate loan with an interest rate of 3.8 percent, you'll save about $2,956 in taxes during the first year of your mortgage. If you instead take out a $200,000 15-year fixed-rate mortgage loan with an interest rate of 3.01 percent, you'll save about $2,470 in taxes your first year of paying back that loan. That's about $480 less in tax savings that first year. And you'll save less in taxes every year thereafter.

Published on October 14, 2008