When mortgages first became popular in the early 1900’s they required a 50% down payment and were subject to variable interest rates. The terms on these types of mortgages were only 5 years, this forced many borrowers to refinance their homes over and over. After the Great Depression, the Federal Housing Administration was created to provide mortgage insurance on FHA-approved lenders. The FHA helped guarantee loans for buyers, establish uniform lending and appraisal standards, and promote homeownership at a perilous time in history. The first to come into play was the 15-year mortgage in the early 1900’s and dominated the market up until the 1950’s when the 30-year was finally introduced.
15 YEAR MORTGAGE
A 15 year mortgage is just that; a home loan that has an amortization period of 15 years. The 15-year mortgage increased in popularity after the FHA was created and instituted the first fully amortized mortgage loans in 1934. In December of 1982, 15-year mortgages were exceedingly popular considering both their monthly payments and interest rates were lower than that of the 30-year, shockingly. However, in today’s lending world that is no longer the case. Though they may have a higher monthly payment, the pros outweigh the cons for some individuals that aim to achieve a free and clear home in half the time of a traditionally chosen 30-year and build equity at a faster rate as well!
PROS
-
Build equity faster!
- With its lower interest rate and higher payment amount, home equity builds at a quicker rate since you pay down the principal balance at a more rapid rate.
-
Shorter path to full homeownership
- Becoming free and clear is a goal that burns bright for many! If having the peace of mind and safety from knowing your home is fully paid off is important to you – this is the mortgage term for you.
-
Long-term savings
- Lenders are subject to fewer years of risk on a 15-year mortgage, this means they charge a lower interest rate. Half as many years of payment = half as many years of interest.
-
Predictability
- Your mortgage payments will always stay the same, no matter how volatile the market may be or the interest rate may climb, your payment will not change.
CONS
-
Larger monthly payments
- Monthly principal and interest payments for a 15-year fixed-rate mortgage run about 50% higher than on a 30-year home loan. Taking into consideration property taxes, insurance and if you put less than 20% down, mortgage insurance. These added expenses may make it difficult to financially respond to emergencies and other needs. Remember – a mortgage is a commitment and the only way out is selling, refinancing, or foreclosure. Make the right choice for you and your financial situation.
-
Opportunity Cost
- Spending more money for a higher monthly payment means it’s not available for other investments or expenditures like home improvements, contributing to your savings or 401(k), vacations, etc.
-
Slimmer home affordability range
- A higher monthly payment for a 15-year mortgage means you’ll qualify for a less expensive loan. This may mean looking at smaller than desired properties or forgoing your dream home/neighborhood. Stretching the loan over 30 years could eliminate these restrictions but commits you to a longer loan term.
30 YEAR MORTGAGE
The most desirable loan term, 30-year mortgage, has been the go-to decision for many homebuyers. The longer term and lower payments have been a selling point for many. Officially authorized by Congress in 1948 for new construction and 1954 for existing homes, their emergence into the mortgage industry was a major game changer for homebuyers looking for lower monthly payments. The 30-year mortgage option afforded many individuals who believed homebuying to be out of reach, the opportunity to accomplish their homeownership dreams.
PROS
-
Lower monthly payments
- This loan type allows for a more affordable monthly payment since it is stretched over a longer period of time.
-
Flexibility
- You always have the option of paying off the loan faster by additional money on top of your monthly payment or even making extra payments, but can always have relief knowing you have the smaller payment to fall back on as needed.
-
Predictability
- Like a 15-year mortgage, your payment will not change!
-
Easier to qualify and more house for the mortgage
- With smaller payments, more borrowers are able to obtain pre-approvals for 30-year mortgages and with a longer loan term they are able to be approved for a higher amount than a 15-year mortgage would allow. Your dream home/neighborhood could be a reality!
-
Opportunity to fund other goals
- Unlike the 15-year mortgage, you have the opportunity to have more money left over after your lower mortgage payment is made each month. That means contributing to your 401(k), achieving financial goals, vacations, and other expenditures is not out of reach!
CONS
-
Higher rates
- Since the lender’s risk of not getting repaid is spread over a longer time, higher interest rates come into play.
-
More interest paid over the term of the loan
- Paying interest for the 30 years adds up to a much higher total cost compared to a 15-year.
-
Slower growth in equity
- It takes longer to build an equity share in a home
-
Danger of over-borrowing
- Qualifying for a bigger mortgage can cause borrowers to take on more they can handle getting a bigger, better home that’s harder to afford. Remember to always calculate in a cushion to prepare for emergencies and life’s inevitable surprises.
-
Higher upkeep costs
- If you go for a home with a higher price tag, higher prices are also associated with it. You will face steeper property taxes, upkeep, and potentially utility bills. Try to budget 1% to 2% of the purchase price for upkeep per year.
WHICH IS RIGHT FOR YOU?
The loan that is right for you should be based on a variety of factors. The biggest thing to consider when choosing between a 15 year and a 30 year loan is the size of the monthly payment that you can afford as well as the financial goals you have set for yourself or your family and which allows for you to achieve such goals. There’s a good reason that 30-year mortgages are typically the more popular choice for homeowners – the lower monthly payments and higher purchasing power is enticing. Though 15-year mortgages do have advantages such as paying less interest overall, the higher monthly payments may be the straw that breaks the camel’s back.
However, if you do choose to go the 30-year mortgage route, it would be a great idea to try and make extra payments on your loan each year. Whether you plan out a faster overall payment plan or just make an extra payment whenever you have the money, those extra payments will go a long way. Saving on total interest paid and working to pay off your mortgage quicker could give you the best of both worlds!