With interest rates as low as they are, a lot of borrowers are being tempted by 15-year fixed-rate mortgages. But for many, a 30-year loan may still be the best option.
To be sure, interest rates on 15-year fixed-rate mortgages are astonishingly low right now -- averaging 2.89 percent, according to Freddie Mac. That can mean some major savings on interest, as well as paying off your mortgage faster. But there are other factors to consider as well.
15 years means higher payments
The downside of a 15-year mortgage is that your monthly payments will be a lot higher than on a 30-year loan. 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 $1370.91 -- and that's before including property taxes and homeowner's insurance.
By contrast, the payment on a 30-year fixed-rate mortgage at the current Freddie Mac average rate of 3.62 percent would be $911.54 -- nearly $460 less than the payment on a 15-year loan.
The potential problem with a 15-year mortgage is the classic one of "you can go broke saving money." Yes, you can save a lot of money on interest with a 15-year mortgage -- in the example above, over the life of the loan, you'd pay only about $47,000 in interest on the 15-year mortgage, versus $128,000 in interest payments on the 30-year mortgage. But how will those higher payments affect your financial picture?
Consider other financial needs
In the example above, note that payments on the 15-year mortgage are half again as much as on the 30-year loan. That's a pretty big bite out of anyone's budget. What else could you be doing with that money? Saving for retirement? For your children's education? How about a reserve fund for unexpected expenses, like a medical emergency?
The big problem with a 15-year mortgage is that it leaves you with less financial flexibility than a 30-year loan. You might be able to manage the mortgage payments most of the time, but what if you hit a tight spot? You can't miss a mortgage payment without financial penalties and damage to your credit score, and getting caught up again can be harder than you think, especially if you were already stretched to cover your monthly payments in the first place.
In addition, the savings may not be as much as you expect. Remember, mortgage interest is tax-deductible for most borrowers, which effectively reduces the savings you get from a 15-year loan.
Paying off your mortgage faster
The situation where refinancing into a 15-year mortgage can be most attractive is when refinancing an existing mortgage. In that situation, you've already been paying on your mortgage for a number of years, so refinancing into a 15-year loan may not shorten the time remaining on your loan that much, so it may seem like you can squeeze your remaining loan into the new time frame.
Keep in mind though, that most of your payments go to interest during the early years of a 30-year mortgage, so you may not have made as much progress in paying down your principle as you think, even if you've had the loan for 8-10 years.
If you want to pay down your mortgage faster, one option to consider is to refinance into another 30-year mortgage, then make payments equal to what you would need to pay it off in 15 years. This lets you pay off your mortgage more quickly, while maintaining the flexibility to make a smaller payment now and then should the need arise.
30-year rates are also cheap
Over the course of the loan, you won't pay a lot more using this approach than you would refinancing into a 15-year mortgage. Remember, even though 30-year mortgage rates are presently running about three-quarters of a percentage point higher than 15-year rates, they're still extremely low by historic standards, and cheap.
Typically, the difference between the two approaches would be about an additional four monthly mortgage payments over 15 years -- fairly cheap, considering the additional financial freedom you gain.
Good money after bad?
One of the undeniable advantages of a 15-year mortgage is that it allows you to pay down your mortgage faster, allowing you to build equity more quickly and brings closer the day you own your home free and clear. If you're refinancing through HARP (the federal Home Affordable Refinance Program) because you're in negative equity, it lets you get back to positive equity more quickly. The question is, do you want to do this?
If you're underwater on your mortgage, many financial advisors would question the wisdom of accelerating your payments on an asset that is worth less than the balance owed. Even if you're not underwater, you should consider whether boosting your payments on a depreciated asset is the best use of your money.
This is a key reason why refinancing back into a 30-year mortgage, even if you've already been paying on the original loan for 10 years or so, can make sense. You're reducing your monthly payments and limiting the additional money you're committing to an asset that has declined in value. If the housing market rebounds and home prices rise again, you'll benefit from the increased equity. Meanwhile, you're limiting the amount of good money you're throwing after bad, while increasing the amount of money available for other uses.
Examine your own situation
This isn't meant to be a hard-and-fast guide to whether or not any one person should opt for a 30-year mortgage over a 15-year one, but only to point out some of the issues involved and the questions borrowers should consider.
For many borrowers, a 15-year mortgage may be the best choice given their finances and personal situation. For others, buying a home with or refinancing back into a 30-year mortgage may be the more sensible option. But you have to look at your own financial situation, the value of your own home and your other financial needs before you can decide which is the best choice for you
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