Choosing Between a 15-Year and a 30-Year Mortgage
Eileen St. Pierre, The Everyday Financial Planner
Buying a home is one of the largest purchases you will make in your lifetime. Many people do not give the term of the mortgage a lot of thought. They immediately pick the 30-year loan because the payments are lower. Many do not even consider a 15-year mortgage, even though they will pay much less interest over the life of the loan.
Here are the numbers:
A 30-year mortgage will carry a higher interest rate than a 15-year mortgage. That’s because the longer you have to pay off the loan, the more risk the lender has to bear. But your payments will be lower because they are spread out over an additional 180 months. So if you take out a mortgage for $250,000, you will end up paying almost $110,000 more in interest on the 30-year mortgage than if you had chosen the 15-year mortgage.
Yeah, I know you’re talking to the screen right now saying “Eileen, I don’t plan on staying in my house for 30 years so I’d rather just have lower payments right now.”
You will build up equity faster with a 15-year mortgage.
Let’s say you plan on selling your house after five years. If you chose the 30-year mortgage, you would have only paid down the mortgage by just under $25,000. With a 15-year mortgage, you will have paid down the mortgage by more than $71,000. That’s almost $47,000 in additional equity.
- Yes, if you go with the 15-year mortgage, you will pay $33,400 more in total payments over this 5-year time period.
- But you get to pocket the extra $13,600 in interest savings.
- If you wait and sell your house in 10 years, the rise in equity (almost $100,000) and interest savings (over $33,000) are even more dramatic.
- So you have to decide if you would rather pay more per month in order to generate higher home equity values and interest savings when it comes time to sell your house.
You can also take the middle road. Go with a 30-year mortgage but add an extra payment each month.
You can make an extra payment each month that will go directly to towards principal reduction. You will not increase your equity as much as going with the 15-year mortgage, but you will pay less in interest than just the straight 30-year mortgage. Here are the numbers:
- If you pay an extra $200 each month, you will pay off your 30-year mortgage 7 years and 1 month faster.
- After five years, your mortgage balance will be $212,221.52.
- After 10 years, your mortgage balance will be $166,528.85.