Is A 15 Or 30-Year Mortgage Better?

June 13, 2018

One of the most common questions we receive as financial coaches is, “Should I do a 15-year or 30-year mortgage?” Maybe you’ve heard that a 15-year is better, but like many financial questions, it really depends on your personal circumstances. Let’s take a quick look at the history of mortgages and explore the criteria for deciding.

Why are mortgages 30 years anyway?

Prior to the Great Depression, mortgage terms were actually shorter, but in order to stimulate home-buying as the economy turned around, the government agreed to back longer-term loans. The thinking on the 30-year loan was that a person would be able to pay off the loan over the course of their working years. This was obviously back when many people purchased one home and lived there for the rest of their lives.

While many credit the 30-year mortgage for fueling the American dream of owning your own home, we have recently started to see a call for the end of the 30-year mortgage due to concerns about the amount of interest that borrowers pay, along with recent abuses of the system. (remember the 2008 financial crisis? Blame it partially on mortgages lent to unqualified borrowers)

That fact of the matter is, in most developed countries, the 15-year mortgage is the standard.

Breaking down the numbers

The concern about the amount of interest paid on a 30-year mortgage is easy to see once you enter it into a calculator. On a $244,000, 30-yr mortgage at 4.5%, the buyer would end up paying $201,000 in interest over the life of the loan PLUS the original $244k borrowed. Compare financing that same amount using a 15-year mortgage at 4% (the shorter timeframe usually also comes with a lower rate). The total amount of interest paid drops to just under $81,000. That is 60% less interest!

That same calculator also illustrates that much of the interest is paid in the earlier years of the mortgage. This is especially important when you consider that most people will not live in the same home for 30 years. If you make 2 – 3 home purchases over your lifetime as many of us now do, while continuing to choose the 30-year option, you are restarting the interest train without making much of a dent in the principal.

Why doesn’t everyone just choose 15 years?

It certainly looks appealing to see that interest amount cut down by 60%, but one mortgage calculation does not settle the debate. When someone chooses a 30-year mortgage, they are exchanging payment flexibility with the cost of the interest. Depending on your circumstances, the 30-year mortgage payment may be better for your budget. Here’s how to decide.

What can you afford?

First, consider the amount of the mortgage in my example above of $244,000. That is the average amount of national mortgage originations. $244,000 could easily help you get into a 3,000 square ft home in my part of Tennessee, but in many areas of the country that same amount wouldn’t even get you into 900 ft condo. Therefore, a 15-year mortgage fitting into your budget will vary depending on where you live. To satisfy your housing needs in certain areas the 30-year may be the better option.

Do you need payment flexibility?

What about future income? Are you planning to go from a 2-income home to 1-income in the future? The lower 30-year mortgage payment offers flexibility for those future changes. One way to hedge would be to pay your 30-year mortgage at the pace of a 15-year, then drop down to the 30-year payment when your life dictates. This will definitely save you in overall interest costs.

How to get 15-year results with 30-year flexibility

One way to give yourself the flexibility of a lower payment over 30 years but with the intention of paying less interest would be to pay the same amount of a 15-year mortgage while signing up for a 30-year mortgage. This is also a helpful way to go about it if you’re already in a 30-year mortgage and don’t wish to go through refinancing.

Typically, 30-year mortgages have a higher interest rate, so it would cost a little more than the normal 15-year mortgage  to do this, but again you keep the flexibility of the 30-year mortgage. If you paid the 15-year payment to the loan in the 30-year example, you would pay off the loan in 15 years and 10 months. The total interest over the life of the loan would be $97,000. In other words, you’d pay an extra $16k over an extra 10 months for that flexibility.

To achieve these results you have to maintain a disciplined approach. One way to make sure the payments occur regularly is setting up an automatic debit from your checking to your mortgage. Also be sure to confirm those extra payments are being applied to principal and not just treated as early payments.

Look at the big picture

It’s important not to make this decision in a silo though. Technically speaking, a 15-year mortgage will always make more financial sense when you’re strictly looking at total interest paid over the life of the loan. However, if committing to the higher monthly payment would compromise your ability to save for the future or potentially cause you to take on credit card debt, then the benefits of saving on interest could be negated by lost opportunity in saving or higher interest paid on credit cards.

Like most things with your personal finances, it’s a trade-off. What is most important to you?