Buying a house is a huge decision that requires long-term planning and budgeting. The process can be confusing, especially for first-time homebuyers looking to find the right location and choose a suitable mortgage plan for the first time. Learn to use a fixed mortgage calculator to find out what is best for you.
Most American homeowners take on 30-year fixed mortgage plans to pay for their homes. While this seems like the default or standard for mortgages, there are actually several mortgage options that can serve various homebuyers depending on their financial situations.
To protect your financial health, it is crucial to assess your long-term plans and current financial status to ensure that the mortgage term you choose is the best fit for your budget. Keep reading to determine whether a 30-year or 15-year fixed mortgage is right for you.
How Mortgage Terms Impact Cost
The same house will cost you a different amount depending on the term of the mortgage you take out. When you take out a mortgage, you have to pay back the capital or borrowed amount as well as the interest your lender charges for the loan. The borrower makes a fixed payment every month, but some of the cost comes from the interest rate which is calculated by the year against the loan’s outstanding balance.
It’s obvious that the interest rate you are charged on your loan will dictate how expensive your mortgage is. What’s less obvious but equally true is that the term over which you agree to pay back your mortgage also has an impact over the cost.
Since the principal amount remains the same for all mortgage terms, spreading it out over many years will mean smaller payments each month. But this may not be the wisest route to take. The longer it takes you to pay off the loan, the more time there is for interest to accrue. So, while your monthly payments are lower for a shorter mortgage term, you will end up paying more in the long run.
What Is the Shortest Mortgage Term?
While a shorter term on a mortgage can save you money, you must also consider how long it will take you to reasonably and affordably pay off your mortgage while handling other expenses. Since buying a home usually requires dealing in large sums of money, 15 and 30-year mortgages are some of the most common mortgage terms.
While you can get a mortgage for under five years, and even as little as several months, most borrowers will renew those mortgages rather than paying off the entire sum within that period.
So, 15-year mortgages are consider to be shorter plans. These will require higher fixed payments every month. However, the same house will end up costing you less with a 15-year mortgage than a 30-year mortgage which will accumulate more interest.
What’s the Difference Between a 15-Year and 30-Year Mortgage?
15-Year Mortgage
With a 15-year mortgage, the outstanding balance is paid off much quicker than if it were to be longer-term. It’s paid off in half the time of a 30-year mortgage.
However, because you have to pay off the principal in a shorter amount of time, the monthly payment is significantly higher. For many, such high monthly payments are simply unaffordable and would compromise their finances and quality of life.
The good thing is that borrowers pay significantly less on a 15-year mortgage. Similarly, 20-year vs. 30-year mortgage rates will differ. So, choosing the shortest term that you can afford will pay off in the end. Consumers who choose to go with shorter-term plans can also avoid loan-level price adjustments, which are the additional fees that usually apply to borrowers opting for lower down payments.
Of course, the difference in the total cost of each option is highly dependent on the interest rate. The average interest rate for American homes was 2.79% in 2021. However, based on the past five years, this can go up to 4.75%. A range of factors influence your particular interest rate, including your state and credit score.
30-Year Mortgage
On the other hand, the 30-year mortgage is much easier to pay on a monthly basis. The principal is effectively spread out over a longer time, so each monthly payment will cost around half of a 15-year loan payment.
Since interest is calculated based on the outstanding amount, you will be charged more interest each month as the balance declines at a slower rate. You also have to factor in loan-level price adjustments, which are more common in longer terms.
If you take a look at the interest on 15-year vs. 30-year loans, or even 20-year vs. 30-year mortgage rates, you’ll find a significant difference. In most cases, the interest rate on 30-year mortgages is higher than 15-year mortgages. This is because as the borrowing term increases, there is a higher risk that the loan will not be repaid.
However, the 30-year mortgage is still a popular and viable option for many homebuyers in America. This is because it is the most affordable on a monthly basis. This allows borrowers to afford the homes they want without compromising on their current spending and financial goals.
Choosing Between a 15-Year Fixed-Rate Mortgage and a 30-Year Fixed-Rate Mortgage
Deciding on the term of your mortgage is a big decision that has a significant impact on your financial future. Your choice should take into account your long-term objectives, goals, and financial reality. Rather than simply taking the mortgage plan recommended by your lender, you should take the time to do the math yourself and find out what option makes the most sense for you financially.
For instance, lets say you are purchasing a house for $374,000 with a $74,000 downpayment. On a 30-year mortgage with a 2.79% interest rate, you will be paying $1,333 monthly with homeowners insurance and property tax. Over 30 years, this amount adds up to $479,880. On a 15-year mortgage, the total amount on this loan would be $364,500. This is without factoring in the different interest rates on long-term and short-term plans.
Of course, it can be detrimental to your current financial health if you were to opt for a 15-year mortgage just to pay less overall. You may be forced to defer important life goals and put your plans on hold. The bottom line is to take a closer look at your individual goals to make a smart choice.
It’s important to remember that even after choosing your mortgage, you can switch to another option if you reconsider by refinancing your mortgage. For instance, if you are struggling to pay off a 15-year mortgage, you may be able to refinance to a 30-year mortgage to alleviate some of the monthly financial burden.
Wondering when to refinance to a 15 year mortgage? If you are easily making your 30-year mortgage payments and could afford higher monthly payments, you should consider refinancing to a 15-year mortgage. Again, this could save you lots of money on interest in the long run. However, you should also consider that there are extra fees involved in refinancing which can dig into these savings.
If you’re considering refinancing to a 15-year mortgage, you should do it as soon as possible. New monthly repayments will be based on the outstanding principal you have on your 30-year loan. However, the main advantage is that you get to switch to a lower interest rate for the 15-year mortgage.
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