There are many different types of mortgage financing options, each geared to serving certain goals. None are bad, though it is sometimes a difficult task to choose the one that is best suited to your particular needs. Adjustable Rate Mortgages (ARMs) and their interest only cousins are often maligned and passed over without consideration, but may be the best option for anyone planning to sell or refinance within a shorter timeframe. But, with long-term rates at historic lows, if there’s any chance of remaining in a home for the long haul, a fixed rate mortgage might be considered cheap insurance.
Once a client has settled on a fixed rate mortgage, I am often asked which option is best for them, a 30-year or a 15-year fixed loan? This begs the following three questions:
- What is the likelihood of remaining in the house or loan for the long term (does the house meet your family’s future needs with respect to bedrooms, schools; is job location subject to change, etc.)?
- Do you prefer to keep housing
- Are you comfortable being locked into the higher payments of the 15-year mortgage?
Although every choice in life carries its respective benefits and costs, with your mortgage the costs are laid out each month with a bill that’s due. And, while you might not be able to address the questions above with crystal clarity, understanding how the fixed options function will help you with your decision. So let’s compare the two mortgages based on a loan of $417,000 with current rates.
30-Year Mortgage fixed at 3.875%
Monthly payments would be $1960.81
In the first year:
Total payments would be $23,530.66
Total interest would be $16,026.40 (68% of payments is interest)
You would own $7504.26
In Year 15:
Total Payments would be $352,959.96
Total interest would be $203,315.15
You would own $149,644.81
In Year 30
Total payments would be $705,919.91
Total interest would be $288,919.91
Cost of interest is 69% of the original loan.
15-Year Mortgage fixed at 3.25%
Monthly payments would be $2930.13
In the first year:
Total payments would be $35,161.55
Total interest would be $13,227.69 (38% of payments is interest)
You would own $21,933.85
In Year 15:
Total Payments would be $527,423.18
Total interest would be $110,423.18
You would own your home free and clear
Cost of interest is 26% of the original loan.
As you can see, the 15-year fixed loan greatly out performs the 30-year fixed mortgage with respect to reduced interest charges and pays off the loan far sooner. This is due not only to the 15-year mortgage’s lower rate, but to the functionality of amortization schedules, which carry forward-weighted interest payments. With the 15-year loan, however, you are locked into payments that are around 67% higher than on the 30-year mortgage. For many, this is a tough burden to manage, especially if income is uncertain.
Have your cake and eat it…
One strategy for reducing overall interest costs while maintaining the option of lower payments is to apply 15-year mortgage payments against the 30-year loan. In the above example a payment of $3058.44 against the interest rate of 3.875% would pay off the 30-year mortgage in 15 years. If you instead applied the $2930.13 payment, the 30-year mortgage would pay off in 191 payments. This might add 11 payments over the 15-year mortgage you could otherwise secure due to the interest rate differential, but the comfort of optional lower payments might be worth the cost.