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Comparing 15 Year and 30 Year Mortgage Terms

by Ryan Guina

A few years ago the real estate market was running wild and real estate brokers and investors did everything they could to get in on the action. That included using exotic mortgages with variable lending terms, interest only loans, and other unique arrangements, such as the commonly referred to “liar’s mortgage” where lenders didn’t actually verify borrower income. All of these exotic financial arrangements helped create a real estate bubble. Mortgage terms adjusted upward, people couldn’t sell their “investment” properties, and the real estate bubble burst, which led to depressed housing prices and hundreds of thousands of foreclosures.

Now we are seeing a return to the basics when it comes to mortgage lending: the 15 and 30 year mortgages. You can often get other terms if you ask, but right now most lenders prefer to offer a fixed rate 15 year or 30 year before offering other options. The purpose of this article is to show you the pros and cons of a 15 year and 30 year mortgage, hopefully giving you the information you need to choose the best loan for your situation.

Shorter terms equals lower interest, but monthly higher payments

Before we run any numbers let’s look at a basic principle of finance. Assuming you are borrowing the same amount of money at the same interest rate, the following will always be true: Longer terms equal lower monthly payments, and shorter terms equal higher monthly payments. But it also means more interest paid on longer terms and less interest paid on shorter terms.

Based on this principle, a 15 year mortgage means you will pay more per month, but you will pay off your loan off with less interest and in less time vs. a 30 year loan which comes with lower monthly payments, but longer terms and more interest paid over the life of the loan.

How much interest will you pay on your mortgage?

One of the first things we need to look at is how much you will spend on your house. Take the total amount borrowed and the interest rate and plug it into a mortgage calculator, such as this Free Excel Mortgage Calculator from Vertex42.

This will give you the total monthly payment, excluding property tax and homeowners insurance.

Note: Before you sign a loan, your lender is required by the Truth in Lending Act to provide you a statement that shows the total amount if money you will pay over the course of the loan if you make each payment as prescribed by the amortization schedule. (Take a look at how much of your money is going toward interest each month. The final number may be shocking!).

15 year vs. 30 year mortgage – Running the numbers

Looking at the final numbers on the amortization schedule, the 15 year mortgage is a clear winner over a 30 year mortgage. As an example, a $250,000 loan at 5% interest results in total payments of $355,857.13 on a 15 year mortgage and $483,139.46 on a 30 year mortgage – a difference of $127,282.33!

Example 15 year and 30 year mortgage payment comparison:

15 year mortgage ($250,000 borrowed @ 5%):

  • Monthly payment: $1976.98
  • Total interest paid: $105,857.13
  • Total amount paid over life of loan: $355,857.13

30 year mortgage ($250,000 borrowed @ 5%):

  • Monthly payment: $1,342.05
  • Total interest paid: $233,139.46
  • Total amount paid over life of loan: $483,139.46

The 15 year mortgage looks like the best option, however, the difference in the monthly payments is $634.93,which is large enough to make that loan unaffordable for many people. (again, these numbers do not include the property taxes or homeowners insurance, which should be the same, regardless of the duration of the loan).

Compare current mortgage rates for a better idea of what is available in your area.

When a 30 year mortgage beats a 15 year mortgage

In most cases, the interest rates on a 15 year mortgage will be slightly lower that that of a 30 year mortgage, giving yet another reason the 15 year mortgage can be a better option that a 30 year mortgage. But there are times when a 30 year mortgage is better than a 15 year mortgage, and it boils down to one word: flexibility.

A 15 year mortgage locks you into a higher monthly payment than a 30 year mortgage. Even if you can make the larger monthly payments that come with a 15 year mortgage, a longer term may offer your more financial flexibility.

Using the example above, the difference in the payments was $634.93 per month. That difference in cash flow may be enough to cripple you should something happen to your current financial situation – for example, job loss, major home repairs, major medical bills, or other unexpected expenses may arise that could cause short or long term financial difficulties.

The lower payments that come with a 30 year mortgage may increase your cash flow and help you with other financial goals, such as paying down debt, contributing toward retirement, saving for college, or just giving your more month to month financial flexibility.

Remember, you can always pay extra on your mortgage each month, but you can’t always pay less.

Which is better – 15 year or 30 year mortgage term?

If you would have asked me a couple years ago, I would have said that the 15 year mortgage term was better by far. The interest rates are often slightly lower and you end up paying less interest overall because you make fewer payments (sometimes hundreds of thousands less in interest).

But if I were to buy a house today, I would choose a 30 year mortgage and make larger payments if I could afford to pay the difference. That way I get the same effect of a 15 year mortgage and can pay it off in roughly the same amount of time, but I also have the option of scaling back my payments if I need the additional cash flow for other needs. The added flexibility is well worth the longer term and slightly higher interest rates.

What are your thoughts on mortgage terms? Do you prefer 15 or 30 year terms?

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Published or updated January 22, 2011.
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{ 14 comments… read them below or add one }

1 Money Reasons

This month is the last mortgage payment I will make on my house. Here is what we did:

We originally went with a 30 year fix mortgage (the interest rate was 6.7%). We build our house, so he had a builder’s loan (yuck).

We build a house that was within our means, so we were able to make double payment at the beginning (until my son was born shortly after). This has a big impact on the duration of the loan.

Later after mortgage rates dropped, we refinanced to a 15% loan (at 4.75 %) that had a payment that was a few hundred dollars less then our original 30 loan (of course the loan was for less money too).

So in total it took us a little more than 10 years to pay off our house. So I think the 30 year mortgage plus a house that you can afford (not one that you think you can afford). is the best approach, at least for us it was! :)

Ironically, given with the great decline in the home values, I consider the extra payments towards our house one of my best investments of money! I’m looking forwards to the extra money I won’t have to pay each month!!!

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2 Ryan

Congrats for paying off your mortgage! The extra cash flow each month will be a nice way to get ahead of the curve with investments or other needs.

I think your example of the 30 year, then refinancing is the right way to go. You bought the house you could afford, then paid extra when you could. Had you purchased a house with the 15 year loan for the original monthly payment you were making (double your 30 year payment) you may have run into trouble when your son came along and you had to make smaller payments.

The key is purchasing a house you can afford with the payment structure you can afford, then finding a way to pay it off earlier if you can or if you want to (Kirk’s comment below about inflation is a great example of when a long term loan can be favorable). The longer term gives most borrowers more flexibility to do just that.

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3 Daddy Paul

In normal times a 15 year loan wins hands down. Often the interest rate is significantly lower making the monthly rate lower for the 15 year than the cited example. That said interest rates will probably not be this low again and home prices are near a bottom making this a good time to buy. If you cannot afford a 15 then by all means get a 30. You can often make additional payments.

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4 Kirk Kinder

Ryan,

This is a thoughtful post on a very important topic. I tend to agree with you that new homeowners should opt for the 30 year mortgage. As you stated, one can always pay the mortgage off early, and the payment flexibility is important, especially during tumultuous times like today.

Second, it isn’t too far fetched that we may face serious inflation in the future. I still believe we are in a deflationary environment as long as the banks aren’t lending and consumers are paying down debt (as evidenced by the negative CPI reading this morning excluding food and energy), but the Fed and government are doing all they can to inflate away debt. In an inflationary environment, having a long dated mortgage is a great thing. Your payments remain the same, but the value of the dollar drops. This allows the mortgage to income ratio to drop considerably. It also allows you to invest the additional cash flow in higher yielding investments; thereby, increasing the interest arbitrage.

I always use the example of my parents who bought a house in the late 60s. At first, the house payment really put a strain on my parents. My Dad had to get a second job to make ends meet. Then the 70s and inflation came. By the time we reached the late 80s, my parents mortgage was laughable. It was less than a car payment.

So I agree that the 30 year is the way to go. Then the homeowner can decide how quickly to pay off the home. If rates remain very low, then pay off the debt quicker as it is difficult to beat a 5% return in most fixed investments. If inflation rears its head, keep the long term mortgage and get a higher after tax return in vehicles that will yield more than your 5% mortgage.

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5 Ryan

Kirk, great point on inflation. That is a topic I’ve thought about in the past, but somehow forgot to mention it in this article. I think the long term flexibility that a 30 year mortgage offers is the way to go for most people. I’m a big proponent of paying off debt early, but it can certainly make sense to take your time repaying your loans if in the case of inflation or better yielding returns elsewhere.

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6 Evan

That extra amount could also be invested and there could be a significant arbitrage between your 5% mortgage and the market.

I wrote about this topic almost a year ago and came to your same conclusion. Flexibility is the most important thing to me

http://www.myjourneytomillions.com/articles/15-vs-30-year-mortgages-longer-is-better/

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7 Ryan

It’s tough to predict investment returns, but yes, there is a good possibility of coming out ahead in the long run. Then again, the idea of retiring your mortgage and increasing monthly cash flow is nice as well. I’m of the opinion that either option is good and people should do whichever they are more comfortable with. :-)

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8 Ken

In this economy/job market I don’t regret having a 30 yr mortages because life will happen to you….I agree with throwing extra at principal when you have it…I’ve had a couple pay cuts in last year so this really rings true to me.

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9 LeanLifeCoach

Ultimately is there any more flexibility than being debt free? We are currently holding a 30 year on a house that we could easily afford. We are paying nearly 30% more each month automatically toward the principle and all bonus/refund/windfalls etc… We hope to have the house paid off in a total of 12 years.

In retrospect, I would have bought an even smaller, less expensive house with a 15 and done the same thing. Today I find it odd that with anything else we start small and build up (cars, jewelry, electronics, luxuries) but when it comes to a home we all have a tendency to buy as much or more than we can afford.

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10 Ryan

Being debt free is the ultimate in financial flexibility, but that isn’t immediately attainable for everyone; the majority of people have either a mortgage or rent payment. But the goal for most home owners is to eliminate the mortgage payment and have more financial flexibility.

In the mean time, it makes sense for most people to create as much flexibility as possible in their budget. Buying a less expensive house is one way to do that, as is using a 30 year mortgage. Even in your case, buying a smaller house would have saved you more money, and using a 30 year mortgage would have given you the flexibility to scale back if necessary, even if you goal would be to pay off your home as quickly as possible.

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11 The Rat

Personally, I would prefer a 30 year, despite a possible higher interest rate. With the 30 year, I would essentially have a smaller payment and allow for me to have more access to my own cash flow. That way, if I wanted to save money for investment purposes or to save a lump sum of cash to pay onto the mortgage’s principal over time, at least that would be an option for me.

Nice thread.

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12 basicmoneytips.com

I think the best thing is to have a 30 mortgage and then make extra payments. If you can afford to pay it off early, rather that be 10, 15, or 20 years, so be it. Plus you have the luxury if something happens that you can drop back to your normal 30 year payment.

However, the downside of this is that we are creatures of habit. Typically if things come up unexpected, rather than tighten our belt, we will go ahead and make the 30 year payment.

I still like the safety net you have with the 30 year mortgage, if you can just be disciplined enough to pay more.

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13 Claudia

Hi,

We purchased our new home in June of 2004. We originally got a 30-year mortgage at a 6% but with the loan rates going down we decided to refinance in November of 2009. We wanted a 15-year loan but with the same payments as with our old 30-year loan so how did we do it? We had to “borrow/refinance” $24K less so that our payments could be exactly the same as before. We now a 15 year loan at a 4.375% . We send an additional $400 a month and an additional $2K to $3K a year. If everything goes as planned, we should pay it off in 9 years! We can’t wait!!

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14 Jennifer

I agree with the last statement

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