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15 Year Mortgage or 30 Year Mortgage? Print E-mail
Personal Finance - Mortgage
Monday, 17 October 2011 02:00

15 year mortgage rates are 3.25% but does it makes sense to refinance from a 30 year mortgage? Everyone has their opinion on how to purchase or refinance a home but the choice is dependent on your situation and personality. So should you pass up an on that ultra low fixed rate mortgage? We weigh the benefits of lower interest rates versus the risk of making higher payments:

15 Year Mortgage Rates:

Currently, the interest gap between 15 year and 30 year mortgages is about 0.5% and can be as much as 0.75%. Half a percent on a $400,000 loan translates to $2,000 a year in savings which is significant. However, that will only offset about 20% of your increase in payments.

Higher Monthly Payments:

The disadvantage of that 15 year is the higher payments. You'll pay $2,860 each month vs $1,910 on a 30 year amortization. Annually, it means you'll have to shell out $13,000 more each year with only $2,000 of that offset by a lower interest rate. No amount of interest savings matters if you can't make your payments and default.

Build Equity Faster:

The big negative for a 30 year loan, especially in a flat or slightly down housing market, is that you hardly build any equity in the first 5 years. After 60 months of payments, you'll barely have built up enough equity (about 9.5%) to pay the real estate commissions and closing costs if you needed to sell. With a 15 year, you are in much better shape, you'll have a whopping 27% equity and wouldn't have issues moving if the market went down 10-15%.

Invest in the Stock Market or Real Estate

Even if you can afford a higher payment, many will argue that the smarter choice is to take that money and invest it into other assets that will yield higher returns. In fact the negative about getting a 15 year mortgage and having higher monthly payments is that you are only getting a 4% return. Over 30 years, the probability that there are better investments (even near risk free), is almost certain. If you are holding a 30 year mortgage and treasuries yield 7% again, you have a chance to invest that extra money and make more than you are paying on your mortgage.

So 15 Year or 30 Year?

There's no one right choice as its completely dependent on both your situation and your appetite for risk. Obviously, in order to take a 15 year, you have to qualify on an income basis. If you do, here's our recommendations for the following situations:

Pro 15 Year:

Significant Other Assets:

If you have significant other assets (stocks, bonds, other liquid investments) then a 15 year carries less risk for you. If you can make several years worth of mortgage payments with your liquid assets and currently have strong enough income to qualify, get the 15 year.

Dual Income:

If you have dual income there is less risk of a complete disruption in your income stream. If one spouse is not working out of choice, and your income allows for it, a 15 year also makes sense. The biggest reason against a 15 year loan is income disruption but a single income plus unemployment compensation and a rainy day fund can usually weather the storm.

Steady Income:

Job security is scant in these times, however, there are a number of positions that enjoy highly a reasonable level of job security. Nurses, doctors, computer programmers, law enforcement and many other positions enjoy a relatively high degree of certainty. In these positions, the goal may be to retire early and a 15 year mortgage helps achieve that.

College Tuition:

So you have a toddler a newborn and think you might have one more in a few years. How's the thought of paying your mortgage every month and shouldering an extra $50,000 a year to foot part of the bill. If you choose a 15 year and pay it off in full by the time your toddler graduates, you'll have no other expenses and you might qualify for more financial aide.

Terrible Savers:

So you make good money, but you're terrible at savings. Use the 15 year as your forced savings plan and when you're done with your mortgage, you'll have more in equity than you would ever save up.

Pro 30 Year:

Lower Payments for Risk Averse:

If the thought of having to make higher payments gives you any pause, then stick with a 30 year.

Committed to Paying Down

If you are the type of person that will pay down your 30 year like it was a 15 and the $2,000 extra in interest is worth the peace of mind of having lower mandatory payments, then go with the 15 year. Be honest with yourself here. Not a lot of people pay their 30 year mortgages off in 15 or even 20 years. It always sounds good upfront but 5 years down the road are you going to be buying that new Toyota instead?

Minimal Savings

If you have minimal savings and retirement funds, go with a 30 year fixed rate mortgage. Any extra money that you would put towards higher payments should go to creating a rainy day fund and some basic investments. You'll also avoid the risk that any income disruption leads to default.

Variable Income

If your income varies a lot year to year, then you'll want to stick with the 30 year mortgage. A bank may qualify you for a 15 year based on your last two years of income but if that might decline significantly, then go with the lower monthly payments.

The decision to get a 30 year or 15 year mortgage is largely a personal one. Figure out what your objectives and situation are and then choose appropriately.

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