Should I take a 15-year or 30-year Mortgage???????

With our currently low interest rates I have several Buyers wrestling with the question of whether to take a 15-year or 30-year mortgage.  My former clients who are (wisely) looking to re-finance are facing the same question.  What is the right answer?  As with many financial questions there is no “one-size-fits-all” answer.  While I don’t claim to be a Financial Planner here are some things to think about.

  • Monthly payments are lower with a 30-year mortgage.  True, and this is why many people choose to go this route.  Since the repayment of the loan is stretched over 30 rather than 15 years each monthly payment is typically less.
  • I’ll pay much less overall with a 15-year mortgage. True, since the loan is paid back much faster the overall interest paid is less with a 15-year mortgage.
  • The interest rate is higher with a 30-year mortgage.  Currently this is true, since the Lender is assuming more risk with a longer payback, the interest rate on a 30-year mortgage is often higher.

Let’s look at a simple example.  Let’s assume you want to borrow $150,000, your Lender tells you that the interest rate for a 30-year mortgage is 3.00% and the interest rate for a 15-year mortgage is 2.75%.  Check out the comparison in the chart below.

Loan Amount$150,000$150,000
Term15 years30 years
Interest Rate2.75%3.00%
Monthly Payment$1,018$632
Total Payments180360
Total Paid$183,228$227,666

In this example the monthly payment for the 15-year mortgage is $1,018 per month which is $386 higher than the 30-year payment at $632.  This is where each person has to look at their situation, are you comfortable locking into the $1,018 payment for 15 years?  This may depend on your income and other monthly expenses. If you are comfortable for a payment this high, the 15-year mortgage is certainly a great idea.

One other option is a blend of the two options.   If you are nervous about locking in to the $1,018 monthly payment you pay want to choose the 30-year option with the lower payment but choose to pay extra directly toward the principal each month, assuming this is allowed by the lender.  The advantage is that you are not locked in to paying extra each month so if your finances are tight at some point you can simply revert back to the lower $632 payment.  One disadvantage to this is that you are paying the loan back with a higher interest rate, 3.00% versus 2.75% in the example above.

How much difference does the interest rate make?  Not too much actually.  Let’s say in the example above you lock in to the 30-year mortgage with the required payment of $632 and you choose to pay an extra $386 each month which would be the 15-year amount of $1,018.  If you did this every month you it would take 4 additional payments to pay off the mortgage because of the higher interest rate. This would cost you approximately $4,000 more over the life of the loan or an average about $270 per year to have the flexibility of paying extra versus being required to make the higher payment.

For some people that flexibility may be worth it and is something you may want to check with your Lender about.