30 Year Mortgage vs 15 Year Mortgage
April 29, 2011
“Would you like a fifteen year or a thirty year mortgage”? You are sitting in a tiny chair with an anxious mortgage broker staring back at you, visibly impatient and waiting for an answer. For you it’s a major decision, but to the broker your just another customer in a long day at work.
So, what will it be? 15 years or 30 years? In some ways it seems like such an arbitrary decision. Yet deep down you know this is the rare decision that is powerful enough to make or break your financial future. So, what factors should you consider when determining what is the best mortgage length to choose? Thanks to contributor Chris Thomas for this article.
There are several factors to consider when selecting the best mortgage length. The major factor everyone tends to focus on is the monthly price differential between a 15 year or 30 year mortgage. For instance, if you are purchasing a $260,000 home, your monthly minimum payments might be something like: $1,800 for a 15 year mortgage and $1,450 for a 30 year mortgage. To be sure, the monthly payment probably is the biggest factor for the average person to consider when selecting a mortgage term. However, the analysis should not end there, for there are a number of other factors to consider when selecting a mortgage length.
Factors for Comparing Mortgages
1) Job Security and Predicted Future Income Levels
At the time you apply for a mortgage, the bank is looking at your finances at a static point in time. However, your financial reality is in fact much more of a moving picture than the snapshot photo the lenders are using. For instance, when my wife and I recently purchased our house, our financial profile “snapshot” was as follows: a young couple with decent jobs, a decent amount of money in the bank, but an even larger amount of student loan debt. That was an accurate portrayal of our current financial reality at the time we applied for our mortgage.
However, as we only recently received our graduate degrees, the hope is that we will with time earn much higher salaries. That is one of the reasons we went with a 15 year mortgage. Although nobody can predict the future, many of us possess an inherent knowledge as to our own job security and expected earnings, both in the near and long-term future. Your age, the amount of years you wish to continue working, and your health should also be considerations when choosing a mortgage length.
2) Future Plans for the House
How much work does the home need? Is it a money pit waiting to happen? How about just your ordinary everyday fixer upper? On the contrary, perhaps the house looks to be completely sound and you do not anticipate many repairs other than basic upkeep for the foreseeable future. These are factors you will have to consider when choosing a mortgage length, because they go to disposable income available, and may dictate which type of mortgage length would be best for you to choose.
To be sure, your expected disposable income/money must be examined in its entirety along with debts/investments as a whole. Simulated budgets reflecting the various monthly payments would also be a smart tool to utilize in determining the proper mortgage length. Finally, you will want to consider how much money you have saved should illness, a job loss, or any other unanticipated issue arise.
3) Interest Rates
Along with the monthly minimum payments, the interest rate is probably the biggest mortgage length factor to consider. If you can swing a 15 year mortgage at a 4.0% interest rate rather than a 30 year mortgage at a 4.8% interest rate, then the amount of money you could save in interest over the life of the loan might be well-worth the extra monies you would have to pay each year. In some cases, you might actually be surprised by how close the monthly payments are as and between a fifteen year v. a thirty year mortgage.
4) Budgetary v. Long-Term Monetary Freedom
If you go with the 30 year mortgage you will likely have more breathing room in your budget each month. At the same time, if you force yourself to instead choose the 15 year mortgage, you will in theory halve the amount of time you carry a mortgage. This will provide you the chance to do things like take on more investment opportunities, to start your own business, or to purchase an investment/vacation property in the future.
Although there generally is no penalty for paying down a mortgage faster than its specific term, you will still miss out on the lower interest rate a fifteen year mortgage offers. Also, despite your best intentions, if you are not careful you may very well find yourself slipping into only paying the minimum mortgage amount each month. Weighing the present budgetary freedom with the long-term freedom of owning 100% of your house sooner is a big consideration.
You will have to factor in the property taxes (as well as utilities, etc), in determining just how much mortgage you can afford each month. On top of that, there are tax benefits to owning a home. Although the tax code is always subject to change, at the present moment the longstanding federal income code home mortgage tax deduction is perhaps the most powerful deduction offered to the average American.
I know several people that have said this home mortgage tax deduction is the reason why they have not paid off their mortgage in full, even though they could. For me, I would rather have the mortgage paid off. Moreover, I note that the math is challenging at best to try and prove that more money is saved by putting off full repayment of a mortgage note. That said, it is a factor that must be considered in the overall mortgage length landscape.
6) Private Mortage Insurance
This type of insurance protects the mortgage company (note holder) if you default on your loan and the house goes into foreclosure. It is generally required if your down payment is below 20%. However, sometimes there are exceptions depending upon whether you are utilizing a 15 year or a 30 year loan.
For instance, FHA loans generally waive the PMI costs if you take on a loan that is 15 years or less and put down 10% or more. That means that the same 10% down payment on a 30 year FHA loan would likely trigger the requirement of PMI insurance. By the way, if you’re not familiar with it, PMI insurance can run pretty steep.
Additionally, this could mean that between the extra monthly PMI payments and the extra interest, the initial monthly payments on a 15 year FHA loan may not be noticeably different from that of the 30 year mortgage note.
7) Time Value of Money, Economic Outlook, & Inflation
I offer here a sort of a “mixed bag” of other factors you may want to consider when determining the best mortgage length for you and your family. The “time value of money” principle basically says that money is worth more now than in the future. This is due, among other reasons, the magic of compounding interest and the historical trend towards inflation. So, if you select the 30 year mortgage and then turn around and invest the extra money in your budget each month, it could cut down on the extra amount of interest you might pay.
At some historical mortgage interest levels this argument might be much weaker, but now that the interest rates on a house are 1-3% points lower than the traditionally “low interest” federal student loans, this argument might now have some traction. Just like nobody can time the market, nobody really knows whether the long-term global/national economic outlook is favorable or not to a 15 year v. a 30 year mortgage.
Even economic experts disagree on whether we are entering an era of rapid inflation, stagflation, or deflation. However, there are various charts and economic trends you may want to consider prior to making a mortgage length decision.
So, hopefully by now you have a better idea of what factors to consider when choosing the best mortgage length for you and your family. It is not an easy decision because so many of these factors are outside of our control. That said, it is important to look beyond just the monthly payments and to also consider other factors such as those addressed in this article.
By looking at this decision globally, you will have a better chance to make the best decision for you. Although this list is by no means exhaustive, it does provide a solid basis of some of the more important factors to consider in determining the proper mortgage length. As with anything, seeking the help of a proper financial expert may be necessary. Keeping all of these factors in mind is difficult, and ultimately is a decision you will have to make on your own (or with the help of a relevant expert).
So, what mortgage length do you think is best for you? Can you think of other factors that should be considered in determining a proper mortgage length? Did you know that some banks/lenders now offer 40 year mortgages?
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All posts by Ben Edwards