There’s no question, the 15-year mortgage has some serious benefits. Not only do you cut your mortgage term in half compared with a 30-year mortgage, but you also save a lot of interest in the process.
But does that mean that the 15-year mortgage is a slam dunk? Hardly. Before taking a 15-year mortgage, you should look carefully at some of the drawbacks. For some borrowers, the 30-year mortgage will be a better choice.
Lower Monthly Payment – And Not Just a Little!
The difference in monthly payments between a 30-year mortgage and a 15-year mortgage is huge. It may even be life-changing!
For example, the payment on a $200,000 mortgage at 4.00% on a 30-year mortgage will be about $955 per month. But the payment on a $200,000 mortgage at 3.75%* on a 15-year mortgage will be about $1,454 per month.
That’s a difference of nearly $500 per month! And it adds up to nearly $6,000 per year. In most households, that’s a lot of money, and it can make a major difference in your monthly budget.
*Rates on 15-year mortgages are typically slightly below what they are on 30-year mortgages.
More Cash Flow for Other Purposes
Because the 30-year mortgage has a lower monthly payment than the 15, you will have more control over your cash flow. That means that you will have more money for purposes unrelated to your home.
This will be important if you need extra money to pay down debt or build up savings. It will also make more money available to simply enjoy your life. That last point is important; a very high house payment is one of the major reasons why some homeowners feel “house poor”. That’s what happens when a disproportionate amount of your budget is going to your home.
One other very important use of the extra money could be to fund investments. This can include retirement savings, college savings for your kids, or even dedicated investments for any other purpose that you choose. This will be important because it will mean that you will have assets apart from your home.
In that way, the 30-year mortgage represents a form of diversification beyond the investment that you have in your home.
You Can Take a 30 year Mortgage and Pay it Off in 15 years – But You Can’t Take a 15 year Mortgage and Pay it Off in 30 Years
This is one of the biggest advantages that a 30-year mortgage has over the 15. You take your mortgage as a 30-year loan, but you always have the option to pay off in 15 years, or even less.
You can do this simply by making your monthly payments based on a 15-year loan term. Using the payment example above, let’s say that your payment based on a 30-year mortgage is $955 per month. If the payment on a 15-year loan for the same amount is $1,454 per month, you can simply make that payment each month. The loan will be paid off as if you had taken a 15-year loan from the very beginning.
You can actually do this with any loan term that you choose. That is, you can make the payments based on a term of 25 years, 20 years, 15 years, or even 10 years.
The biggest advantage of using a 30-year mortgage with a monthly payment based on a shorter term is that you can always resort back to the lower original monthly payment should it become necessary.
The same is not true with a 15-year mortgage. If you determine that the monthly payment on the loan is too high, you will not have the option to make a lower payment based on a 30-year payout.
Preserving One of the Last, Best Income Tax Deductions
Over the years Congress has gradually scaled back on the number of tax deductions we have available, as well as the amount that can be deducted for those that are left. The deductions for home mortgage interest and real estate taxes are among the most generous deductions still available to the average person.
But one of the inherent disadvantages to the 15-year mortgage is that the interest deduction disappears more quickly than it will for a 30-year mortgage. You may even find that a few years into the loan, you no longer have sufficient deductions to itemize on your income tax return.
Just like the 15-year mortgage, the 30-year mortgage will also pay down over time, and lower the amount of interest that you have to deduct. But it will take a lot longer with the 30-year mortgage than it will with the 15.
The Better Loan Term if You Lose Your Job
This is something that a lot of homeowners don’t think much about when they are signing up for a 15-year mortgage. But the higher monthly payment will be more of a burden in the event that you lose your job, or face some other financial catastrophe.
Unfortunately, the loss of your job will also make it impossible to refinance your 15-year mortgage into a 30-year loan, with its lower monthly payments.
Even though a 15-year mortgage will result in faster home equity buildup, that extra equity will do very little good in the event of a financial struggle. Even if there is only a relatively small balance on your mortgage, your monthly payment will continue at a high level until the loan is paid in full. And the extra equity that you have in the home will be difficult or impossible to extract if you’re unemployed.
A 15-year mortgage is an excellent strategy to build equity and to own your home free-and-clear. But before signing up for one make sure that you understand all of the risks that are involved. Once you do, you may decide that a 30-year mortgage isn’t such a bad program after all.