15 or 30-year? Which Mortgage is Right for You?

When it comes to mortgages, many home buyers focus solely on the monthly payment. Rightly so – the purchase price of a home has virtually no bearing on the week-to-week budget of average Americans. The bottom line must be a payment that you can afford along with all of your other expenses.

But mortgages come with a second, equally important, bottom line – the total amount of money you will pay over the life of the loan (principle plus interest). When you think about it logically, it makes sense that you’ll pay more in interest charges if you owe money for a longer period of time. But let’s look at exactly how much more.

The median price for existing homes in the U.S. was around $187,000 at the end of August. Let’s say you borrow that amount at 3.5 percent for 30 years. Your monthly payment will be $840. By the end of the 30 years, you will have paid back the $187,000 plus $115,297 in interest charges, for a total repayment amount of $302,297.

If you borrow the same amount at the same interest rate for only 15 years, your monthly payment increases to $1,337. But the total amount of interest that you will pay on the loan goes all the way down to $53,629! Your total repayment amount is reduced to $240,629.You just saved $61,668 and eliminated a whopping 180 monthly payments.

Many people are surprised by those numbers, and by the fact that cutting the loan’s life in half does not require twice the payment effort (in this case, it’s an increase of about 37 percent). When you shop for a mortgage, carefully consider whether you can afford the higher payment. Don’t forget that five years from now your income should be a little higher than it is now. And 10 years from now, even higher. You could even consider buying a home with a lower price in order to be out of debt sooner.

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Another significant advantage to 15-year mortgages is a better interest rate. Lenders typically offer 15-year loans at rates half a percentage point or more lower than the 30-year rates. Today’s rate on a 15-year mortgage is just 2.85 percent. That translates into even greater savings over the life of the loan. At that rate, the 15-year payment on a $187,000 loan is only $1,278. And the total cost of the loan comes down to $230,029. Could you afford an extra $438 each month in order to save yourself over $72,000?

What are the disadvantages to 15-year mortgages?

The only real disadvantage is the higher payment. In our tumultuous economy, it’s reasonable to wonder if you might experience a period of unemployment during the next 15 years. What if you lose your job some time after you obtain a 15-year loan?

If you’re not comfortable obligating yourself to a higher payment, the best solution might be to obtain a 30-year loan and make a personal commitment to the higher payment anyway. Before you do this, make sure your lender doesn’t impose a prepayment penalty. Then, to help yourself stick to the higher amount every month, set it up as an automatic payment from your bank. Be sure your extra payments are applied to the principle. You might need to specify that on every payment.

The downside to this type of prepayment plan is that you don’t get to take advantage of the lower interest rate. The upside is that if you do experience financial difficulties during the life of the loan, you always have the option of falling back to the lower payment, freeing up money for your other bills.

What about smaller extra payments?

Any additional amount that you can afford to apply to your principle will reduce your total liability and shorten the life of your loan. In our 30-year example, paying an extra $245 each month will take 10 years off the life of your loan, and reduce the total amount of interest paid to $73,266. You save over $42,000 and 10 years of payments.

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Even in the context of record-low interest rates, the advantages of accelerated payments cannot be overstated. Although perpetual debt is commonplace in our society, you needn’t accept it as a way of life.

Kimberly Rotter is a writer, businesswoman and mother in San Diego, CA. She holds a Bachelor’s degree in English, a Master’s degree in Business Administration, and a Graduate Certificate in Distance Education. Kim and her husband own two homes, a couple of vehicles and a few investments, and live with minimal debt. Both are successfully self-employed, each in their own field.