In this difficult housing market — with high mortgage loan rates and a dearth of home sellers because so many are locked in with much lower interest rates — the spread between the 30-year and 15-year rates may not seem very important if you are looking to buy a home.
But it might be the most important thing for you to look into. Or maybe you know someone about to enter the housing market who could be well served by gathering more information.
Most people (and chances are, the loan officers you speak to) work under the assumption that their only choice for financing a home purchase is to take out a 30-year mortgage loan. But doing so can be so much more expensive than the 15-year option that it can cause you financial harm for decades.
And 30 years is quite a long commitment to paying interest, considering how long a typical working career lasts.
If you are looking to buy a home and need to borrow to do so, you should always consider your options. You can use MarketWatch’s mortgage calculator to make a comparison.
To keep things simple and only compare fixed-rate loans (while leaving insurance and property taxes out), we can begin with the median U.S. home listing price of $440,000 in July, according to Realtor.com. For a “conforming” loan — that is, one which your lender can easily sell to Fannie Mae or Freddie Mac, and for which mortgage insurance won’t be required — the minimum down payment is 20%, unless you are eligible for a special government-subsidized program allowing a smaller down payment.
For our example, the home costs $440,000 and the down payment is 20%, or $88,000, so the loan will be for $352,000. For our loan comparison, we used national average interest rates of 7.23% for a conforming 30-year fixed-rate mortgage loan and 6.55% for a 15-year loan as of Aug. 24, according to Freddie Mac.
A fixed-rate mortgage loan is amortized, which means the payment (combined principal and interest) remains the same for the life of the loan, but the weighting of principal and interest changes over time. For our $352,000 loan example, the monthly payment at the national average interest rate of 7.23% for a 30-year loan is $2,396.
For the first monthly loan payment, only $276 is principal, while the rest is interest. Over time this reverses. For example, halfway through the life of the loan, your 180th payment will be weighted $808 to the principal, with the rest being interest. And at that time, you will have paid off $89,152 of the principal. That’s right — after 15 years you will still owe $262,848 on your house. Assuming you didn’t take out a second mortgage loan.
If you had gone with a 15-year loan at the lower rate of 6.55%, your payments would be much higher at $3,076 a month. Your first payment would be weighted $1,155 to principal. You would be finished in 15 years and your total interest paid for the life of the loan would be $201,676.
For the 30-year loan, total interest for the life of the loan would be $510,732. For the first 15 years of the 30-year loan, total interest paid would be $342,216.
So for an extra $679.50 a month, not only do you get the loan off your back 15 years earlier, you save $309,056 in interest.
Arguments against the shorter loan include the likelihood that you will move within a few years. But you don’t really know if that will happen. Five years can go by in 15 minutes.
With the 15-year loan, you build up equity much more quickly. After five years, you will have paid down the balance on a 15-year loan by $81,709, while you will have paid down the balance of a 30-year loan by $19,855. The 15-year loan will put you in a much better equity position if you decide to sell your home and make a move.
Another argument against the shorter loan might be that you would make more money investing the $679.50 a month in the stock market. But would you have the discipline to do this? Or would the stock market have high enough returns during your investment period if you were to sell the home in five years? The beauty of the 15-year fixed-rate loan is that the savings on interest (when compared with the 30-year loan) is guaranteed.
Here’s a summary of attributes for a 15-year fixed-rate residential mortgage loan and a 30-year fixed-rate loan:
|30-year fixed||15-year fixed|
|Loan balance after 60 payments||$332,145||$270,291|
|Loan balance after 180 payments||$262,848||$0|
|Total principal paid – first five years||$19,855||$81,709|
|Total interest paid – first five years||$123,934||$102,850|
|Total interest paid -15 years||$342,216||$201,676|
|Total interest paid – 30 years||$510,732||N/A|
How can you come up with that $679.50 a month? You might delay your next new-vehicle purchase, or buy less car, or both. You might also scale down your home choice to make a 15-year loan possible. A combination of decisions might help you to save an incredible amount of money over the course of decades. Feeling some pain now can set you up for a much easier financial life down the line.
Over time, your loan payment won’t increase, but hopefully your income will go up. At some point you will be glad you were able to tighten your belt and take the 15-year loan instead of suffering under the weight of a 30-year loan.