Why you should — and shouldn’t — get a 15-year mortgage
A home is likely to be the largest purchase of your life. Coming up with a down payment can be hard enough, so spreading out the mortgage payments over 30 years can make a home a lot more affordable. Cutting that time in half with a 15-year mortgage probably won’t be a possibility with your first home.
But later in life, when you’re earning more money, have more equity and plan on staying in a house for years to come, refinancing into a 15-year mortgage can make sense.
As anyone who has looked at a mortgage statement or closing papers on a house knows, the interest paid on a 30-year loan can be almost as much as the principal paid over the life of the loan. That’s one of the first reasons to consider getting a 15-year mortgage.
It can be difficult to take the long view when looking at a monthly mortgage bill that will be 50 percent higher over 15 years instead of 30.
“For the most part, homebuyers are trying to get the lowest monthly payment,” says Rick Bechtel, executive vice president and head of U.S. mortgage banking at TD Bank in Mt. Laurel, N.J.
Paying a home loan off in half the time requires a larger payment, of course, that will save you tens of thousands of dollars, if not $100,000, on interest charges. Why? Not only is more principal paid earlier, but interest rates on 15-year mortgages are usually better than other types of loans.
Bechtel gives the example of a $200,000 mortgage at 30 vs. 15 years:
Mortgage type: 30 year 15 year
Interest rate: 4.5% 4%
Monthly payment: $1,013 $1,479
Total interest: $164,813 $66,288
That’s almost a savings of $100,000 by going with a 15-year loan. Divide that savings over 15 years and it’s about $555 saved per month.
But how to pay the extra amount?
It would be nice if that $555 in monthly savings was in your pocket from the beginning. But it’s not. It’s the savings you’ll see after the loan is paid off.
The main difficulty with a 15-year loan is increasing your monthly payment. In the above case, it’s by $466. Putting that $555 monthly savings into the mortgage would more than pay for it.
But where do homebuyers get money now so they can afford a much higher mortgage each month for the next 15 years?
Because less than 10 percent of homeowners have 15-year mortgages, Bechtel says it’s not an option for everyone, mainly because of the higher payments.
“It’s not for the faint of heart,” he says.
Borrowers should make sure they have enough income to afford it, are able to manage their household debt, and have money in liquid savings for emergencies, he suggests. This is mainly why 15-year mortgages are more of a refinancing option, says Bechtel, who bought his house with a 30-year loan and later refinanced into a 15-year loan that now has six years remaining.
“If I’m going to swallow a bigger monthly nut, knowing that I’ll save a ton of money in the long run,” Bechtel says, a borrower needs confidence in their job prospects or have enough money in savings to cover the higher mortgage if they lose their job or their salary drops.
Repaying a mortgage faster not only saves you money in the long run, but you build equity in your home faster too. If home prices rise, equity could grow more.
This is good for many reasons, including making refinancing easier by lowering your debt-to-income ratio. While it won’t improve your cash flow, it should make it easier to be approved for a home equity loan or home equity line of credit, Bechtel says.
A home equity loan can be used to help pay for college, for example, and repaid if you need the equity back.
An easier retirement
Another big advantage of cutting a home loan timeline in half is that if you plan to retire in the next 10 to 20 years, having your home paid for when you retire won’t hurt your finances in retirement. Instead of a house payment, you can use that money for retirement expenses.
If you continue paying a 30-year mortgage in retirement, you may have to pull money out of your savings to make the payments.
An option that isn’t as disciplined
If you can afford it, a 15-year mortgage is a forced form of discipline of paying off your home early.
But if you’re unsure if you can make the higher monthly payments for 15 years, one option is going half way by keeping a 30-year fixed mortgage but paying it off in 15 years, Bechtel says. It will give you flexibility in paying the higher amount when you can afford it, and cutting back to the normal, 30-year payment amount when you can’t.
The 30-year mortgage will have the higher rate — 4.5 percent in the example cited above by Bechtel — but paying $1,530 per month instead of the regular $1,013 payment will pay off the mortgage in 15 years. Only $75,397 will be spent in total interest, which is $9,109 more than with a 15-year mortgage, and $89,416 less in total interest paid than with a 30-year mortgage.
You’ll need to be disciplined to make the $500 in extra payments each month, but can do that with automatic payments.
“Now you are just into the beauty of forced savings,” Bechtel says.