When home buyers start to consider mortgages, the length of the term makes a significant difference. Choosing a longer term can be more affordable, but usually increases interest costs over time. A shorter term requires a higher payment, but may offer other benefits. The right decision depends on the home buyer's financial situation and goals. With this information, buyers can identify the main differences between a 15-year and a 30-year mortgage, with benefits and potential disadvantages for each.
1. Mortgage Interest Rates and Total Interest Paid
When lenders set interest rates to offer for a mortgage, they have several factors to consider. Some, like the applicant's creditworthiness and down payment, are somewhat under the control of the buyer. Others, like the mortgage term, refer more to industry preferences. A longer loan represents a higher risk to the lender. As such, a 30-year mortgage usually has a higher interest rate than a 15-year loan. Rates vary by the week, but the difference could be as much as 1 percent.
The interest rate and the term length dictate how much a homeowner will pay in interest for the life of the loan. A longer mortgage means more interest paid, even if the interest rates are exactly the same. Buyers who secure a 15-year mortgage will generally pay significantly less interest by the time the loan is paid off. The difference could be tens of thousands of dollars, or more.
2. Monthly Payment and Buying Power
In exchange for a lower interest rate and total interest paid, a 15-year loan tends to come with a significantly higher monthly payment and lower buying power. As a general rule, lenders take a buyer's annual income and divide it by 12 to determine a monthly gross income. A percentage of this number, usually 28-33 percent, is the maximum monthly mortgage payment that an applicant can have. This total includes payments for:
- property taxes
- homeowners insurance and private mortgage insurance, where applicable
Since a 30-year loan typically has a much lower payment, buyers are more likely to qualify for a mortgage with a longer term. This is particularly true for borrowers with modest incomes.
The monthly payment can notably affect people's buying power. In regions with a higher cost of living, buyers may need to take the longer loan simply to qualify for anything in the area. People with limited income or high amounts of other debts may not have the option to consider the higher payment, if they want to qualify at all.
3. Increase in Equity
The term of the loan determines how quickly the homeowner gains equity. A higher monthly payment and a lower interest rate translate into more principal paid off each month. This means that by the end of the first few years, the homeowner will control a larger share of equity in the home with a 15-year loan than a 30-year one. There are many reasons that buyers may want to pay off the loan more quickly, such as:
- more profits if the home needs to be sold soon
- owning a home outright with an approaching retirement
- ability to secure a home-equity loan
- opportunities to refinance
People who already control a large share of the equity in the home, as a result of a large down payment, may not need these benefits. They might prefer a 30-year loan to limit their monthly expenses.
4. Loan Requirements and Options
Getting a 15-year loan is often more difficult than a 30-year loan, and there are fewer loan options. For example, people with lower credit scores or a limited credit history may not be able to qualify for a fixed-rate loan. Mortgages with a 15-year term are almost always fixed-rate. By comparison, 30-year loans may come as a fixed-rate or an adjustable-rate mortgage (ARM). This type of loan features a short period with a fixed rate at the beginning, usually a few years, after which the rate can go up or down. The initial rate is typically lower for an ARM, which may offer people a lower payment until they can refinance.
5. Refinancing Considerations
In many cases, the terms of the original loan serve as a jumping-off point for homeowners when they decide to refinance. The kinds of mortgages that people can get may change for many reasons as they start to pay off the first one, including:
- increase in credit scores
- income or debt changes
- share of equity
- fluctuations in mortgage interest rates
People who got a 30-year mortgage may choose to refinance to a 15-year loan. With a lower loan amount, they can pay off the mortgage faster and may be able to afford a higher monthly payment. Homeowners with a 15-year mortgage may want to switch to a 30-year loan, for a lower monthly payment that provides more flexibility.
Qualifying for a mortgage to buy a new Eagle Ridge home relates heavily to the loan term. By comparing the advantages of a 15-year loan and a 30-year mortgage, buyers can make the choice that suits them the most.