So, you’re ready to buy a house. Yay! Looking for houses is one of the great joys of life. Applying for mortgages, honestly, not so much. It requires a hard look at your finances, by you and some outside eyes, and that can seem daunting and exhausting. However, for most people, it’s a necessary process for getting into their dream home, so understanding what your options are and how to go about making the best decision will help you get it taken care of so you can focus on house hunting.
One decision you will need to make is what mortgage term – 15-year or 30-year – is right for you. This decision comes down to deciding your preference between lower overall costs versus lower monthly payments. There is no right or wrong answer and the key is analyzing what makes the most sense for your short and long term financial stability and success.
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The Difference Between A 15-Year And 30-Year Mortgage
Let’s take a closer look at the main differences between these two loan terms and what they mean for you as you work on buying your new home.
First, understanding the two key components of a mortgage is critical:
- Principal: The amount you borrowed and have to pay back
- Interest: The money you pay each month on top of the principal to compensate the lender for letting you borrow the money
You likely have already realized that since the mortgage principal amount is the same regardless of the term, the longer the term is, the smaller your monthly payments are going to be. Here's what that means for a 15-year vs. 30-year mortgage:
With a 15-year mortgage, the higher payments go into paying down the principal faster, which means lenders are getting their money back faster, which in turn reduces the overall interest paid.
For a 30-year mortgage, you’re paying quite a bit less each month but quite a bit more interest over the course of the loan to compensate the lender for letting you borrow the money for a longer period of time.
As a result, a 30-year term can cost about double what a 15-year term costs. However, even though it’s more expensive overall to do a 30-year term for your loan, there are also benefits that can make this a better choice for some people, depending on their circumstances.
15-Year Vs. 30-Year Mortgage Calculator
Easy-to-use mortgage calculators allow you to insert your sale price, down payment and all the other factors discussed here to get an accurate picture of what you will pay monthly for your new home. This is important to do before you go looking for houses, because it’s always a good idea to know what you can/are willing to pay.
How To Calculate Your Loan Payments
To determine your total costs on a 15-year vs. 30-year home loan, you'll need the following information:
- Total cost of the home
- Down payment amount
- Current 15-year and 30-year mortgage rates
Principal and interest are calculated by using the purchase price of the home, subtracting the down payment, and then adding the interest rate and loan term. If you have a 15-year mortgage, you will make a total of 180 monthly payments. A 30-year loan will have 360 payments.
Example Calculation For Monthly Payments
Let's say you want to spend about $100,000 on your new home and you have $20,000 saved for a 20% down payment, making your principal $80,000. If the rates for a 15-year and 30-year loan are 2.6% and 2.75% respectively, you would expect to pay about $537 per month on a 15-year plan and $327 per month on a 30-year plan.
As you can see, even on a relatively small loan and when interest rates are within 0.15% for both loan options, choosing a 30-year mortgage saves you about $200 every month. Depending on your month-to-month financial situation, having an extra $200 to spare could be extremely helpful. On the flip side, choosing a 30-year loan would cost you around $20,000 more in total by the time you paid off your mortgage.
Additional Monthly Costs
In addition to these variables, there are a number of other costs to include when calculating your monthly payment. The most common ones are property taxes, homeowners insurance and homeowners association (HOA) fees (if applicable). All of these numbers are calculated along with the principal of the loan in relation to the term as well as the interest rate to determine how much you’ll pay each month and how many years you’ll pay it for.
Once the loan is paid off, the only things you need to keep paying are the property taxes, homeowners insurance and any HOA fees.
How To Decide Which Term Is Right For You
There’s a lot to consider around the entire home buying process, and the mortgage part of it is no different. Think about your current financial circumstances and ask yourself the following questions:
- Do you have a good amount saved for a down payment?
- Is there some wiggle room in your monthly budget to pay higher monthly payments so you can pay less over the whole loan term?
- What is the real estate market like where you live?
- Do you expect your monthly income to rise, fall or stay the same in the future?
Carefully considering all of these factors and more will give you the confidence needed to select the right mortgage for your unique circumstances. Don’t let all the financial forensics turn you off from buying a home altogether, though, because any purchase regardless of loan type is better than none at all given the significant advantages from a tax perspective and a building equity perspective.
When Is A 15-Year Mortgage Better?
This can be a great option for borrowers who can afford the higher monthly payments, as it allows them to enjoy the financial – and frankly emotional – freedom of paying off their mortgage. People who benefit from this type of loan also should have a steady, nonfluctuating income to ensure they will be able to make the higher payments over the entire 15 years of the loan.
When Is A 30-Year Mortgage Better?
For the right buyers, there are also a number of benefits in the 30-year plan. For starters, there are substantial tax advantages, especially in the early years, when most of the monthly mortgage payment goes toward interest payments. However, in high-tax states, some of the tax advantages may disappear because of the State and Local Tax deduction cap (included in the 2017 Tax Cuts and Jobs Act).
The most stark advantage, of course, is lower monthly payments, making a smaller household budget and possible fluctuating incomes less of an issue.
Should You Consider A Combo Option (Extra Payments)?
Some home buyers choose to take a middle route that borrows advantages from both the 15-year and 30-year payment plans. Technically, this is a strategy rather than a third loan type. It involves choosing a 30-year mortgage and then making the monthly payments you would on a 15-year mortgage. Just like with conventional payment methods, there are pros and cons to this best-of-both-words approach.
On the plus side, making higher payments on a 30-year mortgage allows you to get out of debt faster. But it also gives you a safety net. On a true 15-year mortgage, you must pay the higher monthly payments. With this alternative method, you have the option of reverting back to the standard, lower monthly payment if your income changes.
The benefit of flexibility comes at a price, however. For one, your 30-year interest rate will remain higher, so if you choose to pay the equivalent of 15-year monthly payments and never need to adjust, you end up paying more than you would have if you had just used the 15-year mortgage to begin with. Additionally, many borrowers find it difficult to stick to the higher monthly payment, since they are the only ones holding themselves accountable for it.
Summary: Pay Now Or Pay Later
Hopefully by now you realize that there are advantages to both the 15-year and the 30-year mortgages, depending on your situation. The simplest way to look at it is the 15-year means you pay less money over the life of the loan, but faster and with a higher payment, and the 30-year means you pay more over the life of the loan, but slower and with a lower payment. Either way, exploring the loan options Rocket Mortgage® has to offer or applying with Rocket Mortgage® are great ways to get started.