15 Vs. 30 Year Mortgage Loan: The Pros And Cons Of Each
When the housing bubble burst in 2007 and spun the economy into the most severe recession since the Great Depression, economists and others predicted that home ownership would plummet. But that didn’t happen. Why? Interest rates dropped and they remain at historic lows.
While it is true that banks and other lenders now put would-be homeowners through heck before agreeing to lend money, home buyers are willing to endure the pain because of low home prices and even lower interest rates.
There are many different types of home loans, but the two most common ones are 15- and 30-year mortgages.
Generally, 15-year mortgages make sense for borrowers who can afford the higher monthly payment because those borrowers will pay much less interest over the length of the mortgage. But there are pros and cons to each.
We’ll start with the 15-year mortgage:
The Pros Of A 15-Year Mortgage
You can repay your mortgage sooner. This is one of the biggest advantages to a 15-year mortgage and it is a great option for homeowners who plan to stay in their homes for a long time. These borrowers decided to make larger payments to get rid of their mortgages sooner. This makes less sense if they don’t expect to be in their houses as long. Then they can spend that extra money on other things.
You can save a lot of money on interest. Anyone who has ever borrowed money with an interest rate knows that the longer it takes to repay the loan, the more interest payments they are making. On the other hand, a loan that is repaid faster means the borrower will pay less for the loan because he is paying less interest. So a 15-year mortgage can save borrowers a ton of money. Here’s an example: Someone with a 30-year, $250,000 mortgage with a 5-percent interest rate will pay $233,139.46 in interest, assuming he does not repay the mortgage early. If he had a 15-year mortgage, he would have paid $105,857.13 in interest – a savings of $127,282.33. That equates to a ton of money.
You can build equity faster. Equity is the difference between what your house is worth and what you owe on it. Homeowners who are “upside down” on their homes owe more on them than they are worth. As the value of the house increases and the mortgage decreases, equity grows. Because borrowers with 15-year mortgages pay less interest than those with 30-year mortgages, they build equity twice as fast.
The Cons Of A 15-Year Mortgage
You must pay more per month. Those with 15-year mortgages have higher monthly mortgage payments and can’t pay less unless they refinance to a 20- or 30-year mortgage. If borrowers lose their jobs or cannot work for whatever reason, lenders typically are unsympathetic. These mortgages often are not affordable for those on a tight budget.
You have less money to spend on other things. Any mortgage represents a large financial obligation, but a 15-year mortgage, because of the higher monthly payment, is a huge obligation. Under the scenario above, with a 15-year $250,000 mortgage with a 5-percent interest rate, the homeowner has a monthly mortgage payment of $1,967.98 -- $625.93 more than the monthly payment with a 30-year $250,000 mortgage.
You receive less of a tax advantage. If you pay less interest, you can write off less interest on your tax returns. It is an obvious tradeoff from all of the savings on interest.
Now we’ll look at the advantages and disadvantages of a traditional 30-year mortgage.
The Pros Of A 30-Year Mortgage
You pay less each month. For many low- and middle-class workers, the option to make lower monthly payments outweighs the benefits of a 15-year mortgage. Thirty-year mortgages make homeownership a reality for millions of Americans.
You can save more money. Those with 30-year mortgages keep more of their money in their pockets, giving them the potential to build a huge nest egg. With interest rates so low, this has become an incentive for borrowers to choose a 30-year mortgage. Let’s look again at the person who borrows $250,000 with a 5-percent interest rate. He pays $1,342.05 per month, and over 30 years, he pays $233,139.46 in interest. That doesn’t sound too good, but if he takes the $625.93 per month he is saving by not choosing a 15-year mortgage and invests that every month, he will end up with $991,686.08 after 30 years, assuming he receives an 8-percent return – the historic rate of return for the stock market.
You can use the extra money to reduce less attractive debt. What’s less attractive debt? Debt that comes with a higher interest rate than mortgages, and that means just about any other debt. Borrowers who can get a 5-percent interest rate very well may have credit cards with interest rates of 15 to 20 percent. College loan debt hovers around 10 percent to 12 percent. Those with 30-year mortgages can use the money not going toward housing to repay credit card debt or other debt that is costing them more money.
You are in a better position to manage financial hardships. If you are paying less per month for housing and you suffer some financial hardship, you have more disposable income to address that hardship. This reality gives the borrower some security and peace of mind – another advantage that should not be ignored.
The Cons Of A 30-Year Mortgage
You pay a lot of interest. It is clear from looking at the advantages of a 15-year mortgage that the biggest disadvantage of a 30-year mortgage is the interest that the borrower is paying to the lender. Let’s look again at the example of the $250,000 mortgage with the 5-percent interest rate. If the homeowner made a down payment of 20 percent ($50,000), he bought a $300,000 house and needs to borrow $250,000. Assuming he repaid the mortgage on time, he paid $233,139.46 in interest. At the end of those 30 years, he paid $533,139.46 for the $300,000 house. He better hope the house appreciates in value at a healthy rate, or he has made a bad investment.
It takes you longer to build equity and repay your mortgage. The longer it takes the borrower to repay the mortgage, the longer that large financial responsibility hangs over his head. Repaying a mortgage sooner gives homeowners financial freedom, freeing up money for everything from travel to financial emergencies.
As you can see, a 15-year mortgage is not for everyone. The same holds true for a 30-year mortgage. There are plenty of pros and cons to both. Before you decide which is best for you, get a handle on your budget. Understand what you can afford and decide what you are willing to pay to borrow the money you need to buy your house.