A 30-year mortgage has long been the industry norm, and for good reason: It allows the homebuyer to spread the loan out over a long period to keep payments as low as possible. But now that interest rates have dropped to near-record lows, 15-year mortgages are becoming more popular. Is a 15-year mortgage right for you?
What Is a 15-Year Mortgage?
A 15-year mortgage is structured to pay off your home in half the time of the traditional 30-year mortgage. With a 15-year mortgage, your interest rate is locked in, so your payments will remain the same from month to month. Because it’s a shorter payoff period, you’ll cut your interest payments nearly in half.
Contrary to what some believe, a 15-year mortgage isn’t simply twice the payment of a 30-year mortgage. In many scenarios, your monthly payment may only increase 50% - 60% while the savings over the life of the loan will be greatly increased. In fact, if your interest rate is 4%, you’ll pay almost 2.2 times more interest on a 30-year loan than you will with a 15-year term. As you can imagine, those interest savings increase if you’re getting a lower rate on a 15-year loan compared to a 30-year, which is often the case.
Low Interest Rates Offer You More Options to Consider
Mortgage rates are at or near the lowest they have been in our lifetimes. Today, rates for 30-year fixed-rate mortgages are below 4% and even lower for 15-year loans. These rates determine how much you will have to pay in interest over the life of the loan. And it can be significant!
For example, on a loan of $200,000, a difference between a mortgage rate of 3% and 4% means a difference in monthly payment of roughly $843 to $954 or $111. That may not seem like a big difference, but over the course of the 30-year home loan, you'll pay back approximately an extra $40,000. That's a lot of retirement money!
There's even more opportunity for you to save with a 15-year mortgage. These shorter loans accumulate less interest and often come with lower interest rates. For example, for a $200,000 loan at Freddie Mac's posted rate of 2.89 percent, monthly payments on a 15-year fixed-rate mortgage would be $1,370.91 (not including property taxes and homeowner insurance). By contrast, the payment on a 30-year fixed-rate mortgage at the current Freddie Mac average rate of 3.62 would be $911.52.
If you can swing the large monthly payment, you'd save roughly $80,000 on interest over the life of the loan and make 180 fewer monthly payments.
Savings, Spending Money and Your Monthly Mortgage Payment
Total debt to repay isn't the whole story, of course. While today's low rates make the monthly payments on a 15-year fixed rate refinance lower than ever before, the payments are higher than with a 30-year loan because you are paying off the loan in half the time.
The resulting difference between the 15- and 30-year mortgage above amounts to $460 a month – that's significant cash flow for most households. If you have a stable job and lifestyle as well as savings to comfortably make the higher payments over the life of the loan, the shorter loan might be a good fit for you.
However, many experts advise against investing the bulk of one's savings into a home because it can limit your financial flexibility in the event of an unforeseen personal financial crisis, such as losing a job or falling ill.
Pros and Cons of a 15-year Mortgage
As with any big decision, there are both pros and cons to choosing this type of mortgage.
Advantages of a 15-Year Mortgage
- You May Secure a Lower Interest Rate. Long-term loans are risky for banks, because there’s much more time for a borrower to default on them. While 15 years may not seem like a “short” period of time, it’s half as long as traditional mortgages and banks can often offer a lower interest rate because their risk decreases.
- You’ll Pay Less in Fees. Government sponsored lenders (such as Fannie-Mae) charge fees, commonly called “loan level price adjustments” to people with lower down payments and/or credit scores. However, these fees often don’t apply to those who choose a 15-year mortgage, and when they do, they’re generally lower than those with 30-year mortgages would pay.
- You’ll Save Money in the Long Run. While the price of the house you’re buying will remain the same whether you finance it for 15 years or 30, you’ll save significantly on interest, as you’ll be paying it over a much shorter period of time.
- You’ll Earn Equity Faster. Equity is based on the payments you make toward the principal of your loan, and because your payments will be significantly higher with a 15-year mortgage, you’re earning more equity each month than with a 30-year loan.
Disadvantages of a 15-Year Mortgage
- You’ll Spend More Money Every Month. Because you’re cutting your repayment schedule in half when compared to a traditional 30-year mortgage, you’re going to pay significantly more each month -- albeit for a shorter period of time.
- You’ll Have Less Flexibility. If you have a 30-year mortgage, you can choose to pay extra each month as finances permit. This “extra” generally goes straight toward your principal. However, if you have a 15-year mortgage, you’re already paying twice the amount, and you have no ability to stop paying that “extra” if finances get tight.
- You Lose Out on Other Investments. If all your money is going into your mortgage, you may not have the liquidity to contribute to other areas that may be important to you – think tax-advantaged 401(k)s, college savings plans for your children, CDs or the stock market.
- You May Lose Out on Your “Dream Home.” While the low interest rate and reduced repayment schedule often entice buyers to opt for a 15-year mortgage, you may find that you’re priced out of your dream home because the monthly payment is more than you can afford.
When debating between a 30-year or 15-year mortgage, it’s best to consider your own unique situation and the factors that are important to you.
Should I Refinance My 30-Year Mortgage to a 15-Year?
If you are already in a 30-year mortgage, you may have the chance to refinance to a lower interest rate. Today's low interest rates offer you the option of further reducing your monthly payment by sticking with a 30-year loan OR shaving years off your mortgage by refinancing to a 15-year. Depending on the interest rate on your current mortgage, you might be able to refinance to a 15-year loan and keep the same monthly payment.
Let’s evaluate two different scenarios – one where you should refinance, and one where you shouldn’t.
Scenario #1: Sound Financials and a Long Term Plan
You are financially stable. You may have been at your job for years, or you may be retired with a guaranteed pension. You plan on staying in your home for the long term, and you have enough money in an emergency fund to live for a year or more, should your situation change unexpectedly. You have the means to make the higher payments without creating a strain on your lifestyle or existing expenditures, and you have plans in place to save for your future.
In this case: Refinance to a 15-year mortgage. You’ll reap the rewards of lower interest rates and a faster payoff.
Scenario #2: High Earner in an Unstable Job Market
You have recently started a new job and you’re making big bucks for the first time and you want a nice home, but the market is unstable. You don’t want to commit to a lengthy loan term since you may need to relocate for work. And, while you have an emergency fund, it is not enough to cover your bills and living expenses for a year, and you’re worried about what would happen if you became suddenly unemployed, injured or otherwise unable to work.
In this case: Stick with your 30-year mortgage. You can always pay more than the minimum amount due to pay it off faster, but you’ll have the flexibility to use the money where the money is most needed.
Before making your decision, use online tools such a refinance calculator to help you evaluate the decision and understand the benefits and risks of each path.
The Bottom Line for 15-Year Loans
With interest rates at historic lows, many homeowners or buyers may be tempted to choose a 15-year fixed-rate mortgage over the more typical 30-year mortgage. The 15-year enables you to pay off your loan faster and likely lock in a lower interest rate, but will come with higher payments. To make a smart decision, you need to determine what's most important to you: financial flexibility or paying off your mortgage faster.
15-year fixed rate loans are great for borrowers who:
- Have a stable job and income
- Already have saved a nest egg for emergencies
- Can comfortably make the higher monthly payments
- Want to eliminate their mortgage debt faster
Still need more information? Whether you’re interested in a traditional mortgage, refinancing to a 15-year loan, or just have questions, we are here for you. Get in touch with a PennyMac Loan Officer today.