Most mortgage loans come with an option for term length: 30-year or 15-year. Many homeowners select a 30-year fixed rate mortgage as a way to save money on monthly payments. Here, we go through the pros and cons of each type of loan.
A 30-year mortgage is set up to be paid off in 30 years. With this, borrowers have a lower monthly payment, as they have double the time to pay off the loan. A lower monthly payment allows borrowers to save up money in different ways: a retirement fund or college savings, for example. Homeowners also have the opportunity refinance or prepay the mortgage if they want to pay the mortgage off faster.
Because a 30-year mortgage is a bigger risk for lenders than a 15-year mortgage, the interest rates are higher on the loan. A 30-year mortgage could have an interest rate .25%-1% higher than a 15-year mortgage loan. In addition, loans from government-sponsored companies like Fannie Mae and Freddie Mac charge loan level price adjustments that are higher for 30-year mortgages.
Borrowers also have the option of paying off a loan in 15 years. Since this type of loan also typically has lower interest rates and lower price adjustments, homeowners will save a significant amount of money over time.
Let’s take a look at this example: a mortgage for a $300,000 home with 10% down payment. If the interest is 3.4% for a 15-year loan, you will pay $1,917 per month. The total cost over 15 years would be $375,051. The same home with a 30-year mortgage might have an interest rate of 4.1%. The cost would be $1,305 per month, equalling $499,670 over the term of 30 years. In this scenario, the 15-year mortgage would save you $124,619.
The downside of a 15-year mortgage is, of course, the higher monthly payment. This may mean you have to buy a smaller home or put less into your savings accounts.
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