When you’re shopping for a mortgage, the two most common fixed-rate mortgage terms you’ll come across are thirty years, and fifteen years. There are other options, sure, but those are the most common.
Fifteen years is a long time. So is thirty years.
Looking at today’s interest rates on both 30-year and 15-year loans, the 30-year rate right now (remember they change a lot) is 3.94%, while the 15-year rate is 3.24%. While the rate on the 30-year term is higher than the 15-year, the monthly payment is actually lower, because the term of the loan is longer. Confused yet? Let’s take a look at how it works out.
According to the New River Valley MLS, the average price of a home sold in Blacksburg VA in 2011 was $251657 – we’ll round down to $250000. (See what $250000 in Blacksburg gets you here). Now see that calculator to the right of this post, the one that says “Estimate Your Payment”? Let’s enter in a few variables to see what a 30-year loan vs. a 15-year loan looks like
- In Principal enter $250000
- In Interest enter 3.94% (for a 30-year loan)
- For Term choose 30 years
- In Down enter $50000 (meaning we’re taking on a $200000 loan)
- In Taxes enter $2000
- In Insurance enter $1000
- Hit Calculate
For a 30-year loan, the monthly payment (with the variables above) works out to $1197.92 a month (Disclosure – I’m not a lender.
For a real lender, go here). And if you go a little further down and click on
Amortization Schedule, you can see exactly how much of your monthly payment goes to pay interest, and how much of it goes to pay principal, each month. If you held the loan for the full 30 years? You’d pay a whopping
$141253.83 in interest alone.
Using the same criteria as above on a 15-year loan raises your monthly payment to $1559.24 a month, an increase of almost 25% – that’s significant. But here’s where the value of a 15-year loan comes in. Click on Amortization Schedule again, and scroll to the bottom of the Interest column … $35662.97 is the total amount of the interest you’d pay by holding the loan for a full fifteen years, a savings of more than one hundred thousand dollars over a 30-year loan ($105590.86, to be exact).
Don’t like numbers, and need a visual? Here you go (courtesy of
Quicken Loans) …
30-year Amortization Chart
15-year Amortization Chart
As you can see, it will take 12 years on the 30-year loan to get to a point where you’re paying more in principal than you are in interest, whereas on the 15-year loan you’ll start paying more in principal than in interest
right away. Of course, the likelihood of someone holding a mortgage for thirty years – or even fifteen years, is slim. But look at the savings over just five years (thanks to
GoodMortgage.com for the calculator):
If you have a 15-year mortgage you’ll have almost $37000 more in equity than if you had a 30-year mortgage, using the same variables as above.
See why, if you can build the payment into your monthly budget, a 15-year mortgage just makes sense?
Glad you like it, Sara, but don’t lose too much sleep on this – there are more than six ways to skin a cat.
There isn’t a “best way” to pay off your mortgage (in my opinion), other than just making sure you make your payment every month. You’re right – you could overpay every month; the reason why I don’t like this scenario is because I am forced to direct the mortgage company, every month, to apply the extra to principal. Natalie and I had this scenario on our last mortgage, and in fact had BOA set up as two separate billers in Bill Pay so as to be certain that they’d apply the correct amounts to principal, and often they failed to do so. That’s one reason why I like the 15-year option, because my “overpayment” every month is built into the payment already, and then anything else I want to add on top is gravy.
Nevertheless, what you’re describing is certainly allowed – I know of no conventional, residential mortgage loans that have prepayment penalties any more (they may be out there, I just don’t know of them). There are plenty that are going to suggest the 30-year mortgage and send in the extra payment each month – I can’t make an argument that that’s the worst idea in the world, either. If something drastically changed you could always use the equity you’ve paid down on a 15-year mortgage and refinance into a 30-year, the unknown is what rates would be at the time of the refinance.
At the end of the day both are viable solutions to the end goal, which is being debt-free, and then you don’t have to worry about it, and I can tell you it’s a great place to be! See you Sunday.
Jeremy, I just love your blog. This dilemma (15-year vs. 30-year) has caused us a lot of late-night math equation crunching. Our question is: What if you get the 30-year loan terms, but then CONSISTENTLY over-pay 25% each month, directing the overpayment to principal only. In that case, you would build equity at an even faster rate than the 15-year loan, but would be protected from mortgage prison if your financial situation drastically changed. Is that allowed?