18 May Back in Vogue – the 15-year Mortgage Term
Historically, money is about as cheap as it has ever been. At today’s rates a 30-year mortgage is yours for around 4 percent per year, and 15-year mortgage rates are about a percentage point lower. These rates provide a great opportunity for first-time buyers to take the plunge into home ownership and for millions of existing home owners to refinance to a better rate.
Most borrowers in the market for a mortgage shop around to find the product with the best rate. However, 85 percent of those borrowers only compare 30-year products, the default term for new home loans. Some buyers do not even realize that 15 or 20-year mortgages exist, or think that 15-year repayments will bust their monthly budget. This is a misconception. For many borrowers, a 15-year mortgage will significantly reduce the overall cost of the loan and let them pay off their mortgage much faster.
Fifteen Year Loan Costs Less Overall
When you take out a mortgage, you agree to pay interest on the outstanding balance of the loan. Interest is factored into your monthly repayment. Every month, some of your payment pays off the interest and anything left over pays down the principal of your loan. In the early years of a loan the majority of your payment goes towards the interest. It’s only in the last 10 years of a 30-year loan that you begin to make significant headway into the amount you borrowed.
A 15-year is amortized on an accelerated schedule. You pay less interest overall because interest accumulates over half the time. Also, 15-year rates are typically lower than 30-year rates, which further pushes down the cost of your loan.
You’ll Pay Off A 15-year Mortgage Faster
A 15-year mortgage term is half the length of a 30-year mortgage term. Provided you keep up your payments, in just 15 years you will own your home free and clear of mortgage debt. This makes sense for some borrowers. Those approaching retirement or home owners wishing to redirect money into college fees for their children have a lot to gain from an accelerated mortgage payment schedule.
Monthly Payments are Larger … but Probably Not as High as you Think
Paying back the principal in half the time means a larger monthly payment. The question is, how much? The answer depends on your rate and how much you borrow — but the chances are your 15-year monthly payment will not be as large as you think, and certainly not double the 30-year mortgage payment as some borrowers believe.
Suppose you take out a $300,000 30-year loan with a low 3.95% interest rate. Your monthly payment will set you back $1,425. By contrast, a 15-year loan for the same amount with a 3.25% rate will cost $2,100 — $675 more each month. For some borrowers, that extra payment puts the 15-year mortgage out of reach. Others will choose the 30-year fixed-rate mortgage because the smaller payment gives greater financial flexibility. You will have cash in your hand for everyday expenses, or to pay into your pension post, or to invest in your home. The higher monthly payment on a 15-year mortgage gives you much less wriggle-room for everyday spending and saving.
Look at it from a long-term perspective, however, and the savings are quite dramatic. The 30-year borrower in the above example pays back $513,000 over the life of the loan. By contract, the 15-year borrower pays back just $378,000. That’s a saving of $135,000 — almost enough to buy a new home!
You’ll Build Equity — Fast!
Home ownership is an investment. It’s a personal investment in your family’s security and future, and it is also a financial investment that, if the market plays fair, could offer significant returns in the form of house price appreciation. But home ownership is also a liability. In fact it’s a very large liability — probably the largest you will ever have.
If buy a home with mortgage finance, your property remains a liability until you pay off the loan or build significant equity. At that point, your home becomes an asset. High equity is important as it allows you to:
- Borrow against your home with a second mortgage or a home equity line of credit
- Refinance your home to a better rate
- Up-size or buy a second property using the equity in your current home as a significant down payment.
With a 15-year loan you will build equity in half the time it takes a 30-year borrower to accrue the same amount.
The Bottom Line
Which mortgage term is right for you? Well, it depends on a variety of factors, such as how much money you can afford to pay in housing costs each month and whether you’d be better spending the extra monthly payment elsewhere. If you do choose a 15-year mortgage, be sure to address every contingency. If you lost your job or took a pay cut, could you still pay the mortgage? If a financial emergency came up, could you cope? Do you have enough money left over to pay into retirement plan? If the answer to those questions is yes, ask your mortgage broker about a 15-year mortgage term. You’ll be amazed at what you can afford –and how much you can save.