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Mortgage Breakdown: 15-Year v. 30-Year

By manybanking.com Staff
When choosing a mortgage, borrowers have to make a number of important decisions. One of those decisions is how long the payback period should be. The most common term lengths are 15 years and 30 years. Which of these two options is best has long been debated. The best answer is, it depends.

Category Product: 
Mortgages
Category Finance: 
Personal Finance
Keywords: 
Mortgages, APR, APY,
Introduction: 

By manybanking.com Staff
When choosing a mortgage, borrowers have to make a number of important decisions. One of those decisions is how long the payback period should be. The most common term lengths are 15 years and 30 years. Which of these two options is best has long been debated. The best answer is, it depends.

The 30-year mortgage is the workhorse of home loans. It is the most common type of mortgage and has been for years. With the 15-year mortgage, however, borrowers get slightly lower interest rates and can accrue equity much faster. On the other hand, a 15-year mortgage also has higher monthly payments in comparison to a 30-year mortgage. Additionally, because the payments are stretched over twice as much time, borrowers pay significantly more interest with at 30-year mortgage. That also means they receive more from mortgage interest tax deductions as well.

In order to choose which one might work best for your particular financial situation, consider this example:

On a $200,000 home, a 30-year mortgage carries an interest rate of 5.31% and a 15-year mortgage has an interest rate of 4.94% (the current national averages according manybanking.com. The monthly payment for the 30-year mortgage would be $1,111.85. The monthly payment for the 15-year mortgage would be $1,575.34. The 15-year mortgage will cost the borrower $463.49 more each month. The 30-year mortgage, however, will ultimately cost $116,705.50 more in total interest paid over the life of the loan  ($200,267.62 - $83,562.12). Use the Mortgage Loan Calculator to crunch the numbers.

Ultimately, the choice of which term length is best depends heavily on the current financial situation of the borrower. If the borrower has a substantial emergency fund saved up and has met all other financial obligation such as retirement savings and college funds, getting a 15-year mortgage is a good way to help that borrower get out of mortgage debt in half the time. If those conditions are not met, however, the money saved on a monthly basis by opting for a 30-year mortgage may be better used elsewhere.

In the event of an emergency such as a sudden accident or illness, not having a stash of sufficiently liquid holdings can be disastrous. On top of the added expenses of the emergency, having a 15-year loan would also produce strain because of the higher monthly payments. Home equity is not liquid enough to provide for emergencies. For those who do not have an ample cash reserve (at least 3 to 6 months worth of expenses, as a rule of thumb), the $463.49 saved each month in the previous example would be better spent building up a proper emergency fund.

If your goal is to pay off your mortgage in as little time as possible, one way to do so without sacrificing cash liquidity is to pay the difference in monthly payments as well as any mortgage interest tax savings (spread into equal monthly installments) to a high-yield savings account like a money market.

In the previous example, the ending principal balance in year 15 of the 30-year mortgage would be $137,770.33. In order to save that amount in 15 years at a 3% return, you would have to save $607 per month. That’s only an extra $1722.12 each year on top of the $463.49/month saved by choosing a 30-year mortgage. That amount is less than the mortgage interest tax savings in the 28% tax bracket even in the 15th year of the loan when the interest paid is the least ($7.485.43 x 0.28 = $2.095.92). At then end of 15 years, you could use your accumulated savings to pay off the remaining balance on your mortgage, and you would have had easy access to those funds throughout.

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The 30-year mortgage is the workhorse of home loans. It is the most common type of mortgage and has been for years. With the 15-year mortgage, however, borrowers get slightly lower interest rates and can accrue equity much faster. On the other hand, a 15-year mortgage also has higher monthly payments in comparison to a 30-year mortgage. Additionally, because the payments are stretched over twice as much time, borrowers pay significantly more interest with at 30-year mortgage. That also means they receive more from mortgage interest tax deductions as well.

In order to choose which one might work best for your particular financial situation, consider this example:

On a $200,000 home, a 30-year mortgage carries an interest rate of 5.31% and a 15-year mortgage has an interest rate of 4.94% (the current national averages according manybanking.com. The monthly payment for the 30-year mortgage would be $1,111.85. The monthly payment for the 15-year mortgage would be $1,575.34. The 15-year mortgage will cost the borrower $463.49 more each month. The 30-year mortgage, however, will ultimately cost $116,705.50 more in total interest paid over the life of the loan  ($200,267.62 - $83,562.12). Use the Mortgage Loan Calculator to crunch the numbers.

Ultimately, the choice of which term length is best depends heavily on the current financial situation of the borrower. If the borrower has a substantial emergency fund saved up and has met all other financial obligation such as retirement savings and college funds, getting a 15-year mortgage is a good way to help that borrower get out of mortgage debt in half the time. If those conditions are not met, however, the money saved on a monthly basis by opting for a 30-year mortgage may be better used elsewhere.

In the event of an emergency such as a sudden accident or illness, not having a stash of sufficiently liquid holdings can be disastrous. On top of the added expenses of the emergency, having a 15-year loan would also produce strain because of the higher monthly payments. Home equity is not liquid enough to provide for emergencies. For those who do not have an ample cash reserve (at least 3 to 6 months worth of expenses, as a rule of thumb), the $463.49 saved each month in the previous example would be better spent building up a proper emergency fund.

If your goal is to pay off your mortgage in as little time as possible, one way to do so without sacrificing cash liquidity is to pay the difference in monthly payments as well as any mortgage interest tax savings (spread into equal monthly installments) to a high-yield savings account like a money market.

In the previous example, the ending principal balance in year 15 of the 30-year mortgage would be $137,770.33. In order to save that amount in 15 years at a 3% return, you would have to save $607 per month. That’s only an extra $1722.12 each year on top of the $463.49/month saved by choosing a 30-year mortgage. That amount is less than the mortgage interest tax savings in the 28% tax bracket even in the 15th year of the loan when the interest paid is the least ($7.485.43 x 0.28 = $2.095.92). At then end of 15 years, you could use your accumulated savings to pay off the remaining balance on your mortgage, and you would have had easy access to those funds throughout.

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