15- vs. 30-Year Mortgages: Which Is Best for Me?

Kailey Fralick, The Motley Fool

Updated Sat, Oct 20, 2018, 12:20 PM

15-year mortgages and 30-year mortgages appeal to different audiences. One helps you reduce the overall cost of your mortgage in exchange for a higher monthly payment, while the other offers lower monthly payments if you're willing to pay the lender more over the lifetime of the loan.

The most popular loan term is 30 years, but this isn't always the best choice. For some people, a 15-year term may be a better fit. Here's a quick example illustrating the differences in monthly and overall costs between the two loan terms.

The costs

Let's assume you're interested in purchasing a $250,000 home, and you can afford to put 20% down, so you won't have to pay for private mortgage insurance (PMI). This means you'll need to borrow $200,000. The average interest rate on a 30-year mortgage today is about 4.7%. This means your monthly payment would be about $1,037, and you'd pay a total of $423,000 over the 30-year loan term, including your down payment and interest.

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Fifteen-year mortgages often have a lower interest rate, because the shorter loan term reduces the risk to lenders. This helps to lower the amount that you'll pay over the life of the loan. However, your monthly costs will be higher, because you're paying for the home in half the time.

The average 15-year mortgage interest rate today is 4.1%. That amounts to a higher monthly payment of $1,489. However, you'll only end up paying a total of $318,000 when all is said and done. That's a difference of $105,000.

How to decide

A 15-year mortgage can be the right decision if you're looking to minimize the overall cost of your mortgage. However, you have to ensure that you can afford the higher monthly payment. You don't want to put yourself in a position where you're struggling to cover your monthly costs. If you found yourself unable to make your payments, you could lose your home.

When you choose a 30-year mortgage, you're resigning yourself to paying a lot more over the course of the loan. But you have a lower monthly payment, and this can help you in two ways. First, it may allow you to purchase a more expensive home than you would be able to afford if you were using a 15-year mortgage. Second, it frees up your cash so you can put it toward other goals, like building up an emergency fund or saving for retirement. If you invest that money, it's possible that your investment returns will be greater than the interest rate you're paying on a 30-year mortgage, especially if your portfolio is stock-heavy.

It isn't set in stone

You'll need to decide which loan term you want when you purchase the home, but you're not locked into this decision forever. If you find that your 15-year mortgage payment is starting to put a strain on your budget, you can always refinance and switch to a 30-year mortgage down the road. Keep in mind, though, that you'll have to pay closing costs all over again when you do this.

Another option is to go with a 30-year mortgage but make larger monthly payments in order to pay it off ahead of schedule. You could even pay off a 30-year loan in just 15 years if you paid enough every month. This would save you a lot of money over the course of the loan, though it would likely still cost you more than a 15-year mortgage, given that 30-year mortgages tend to have higher interest rates.

Take our previous example. If you were going to pay off the 30-year mortgage with a 4.7% interest rate in 15 years, you would need to pay $1,551 per month. Over the course of those 15 years, you'd only end up spending $329,000. You'd save $94,000 by repaying the loan in half the allotted time -- though the 15-year loan with a 4.1% rate would be $11,000 cheaper overall.

The nice part about this approach is that if for some reason you find yourself unable to make the higher monthly payments, you can always fall back on your standard monthly payments without fear of losing your home. However, you need to make sure your mortgage doesn't have a prepayment penalty. These don't usually kick in unless you pay off more than 20% of your mortgage balance in a single year, but make sure you look into this before signing on the dotted line, because prepayment penalties can significantly reduce the savings of paying off a mortgage early.

It's important to think carefully about how much you can afford to pay per month when deciding on your loan term. But you also have to think about the best use for your money. For most people, a 30-year mortgage is the smart approach, because it gives them more money to put toward their other financial goals, and they can still pay the loan off ahead of schedule if they choose.

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