30 yr. Fixed Rate Mortgage vs. 15 yr. -- Which One Is Right for You?
When you decide to purchase a home there are a variety of decisions that must be made such as where you want to live, how many bedrooms you need, and what style of house you hope to call home. Along with decisions about the home itself you will need to make some important decisions regarding home financing. One of the most important considerations when financing a home is what type of mortgage to take out. There are two basic types of mortgages -- a fixed rate and an adjustable rate mortgage, or ARM. Most buyers choose a fixed rate mortgage for the stability it affords. If you have decided to use a fixed rate mortgage for your home financing you will then need to decide whether to take out a 30 year fixed rate loan or a 15 year fixed rate loan. Understanding how each works and the advantages and disadvantages of each should help you make your decision.
A fixed rate loan offers the borrower the security and stability of knowing what the monthly payment will be for the life of the loan. If you take out a 30 year fixed rate loan, your first monthly payment will be for the same amount as your last, thereby eliminating the risk of your monthly payment increasing as it can occur with an ARM. Traditionally, fixed rate mortgages generally meant you would have a 30 year repayment schedule. In recent years, however, 15 year fixed rate mortgages have gained in popularity.
Financing a home with a 15 year fixed rate mortgage typically means you will have a lower interest rate but a higher monthly payment. Even though the interest rate is lower, keep in mind that you are paying off the loan in half the time, making the monthly payment higher. By way of illustration, let’s assume that you need to borrow $200,000 to purchase your home. As of December, 2013 a 30 year fixed rate FHA loan averages about a 4.6 percent interest rate while a comparable 15 year loan averages about a 3.8 percent interest rate (NOTE: these numbers are general estimations and your interest rate will vary depending on different factors like your credit score). Your monthly payment on the 30 year loan would be something like $1,025 while your payment on the 15 year loan would be $1,459. After five years you would have paid just over $33,000 in interest on the 15 year loan and just over $44,000 in interest on the 30 year loan. At the end of the loans, you will have paid $62,694 in interest on the 15 year loan or a significantly higher $169,104 in interest on the 30 year loan.
While these figures appear to point toward financing a home with a 15 year loan, there are reasons why you may not want to do that. Most importantly, you must consider the significant difference in monthly payments. If you can easily afford the additional $400 per month then you may decide to go with a 15 year loan; however, if the extra $400 will be a strain on your budget you may wish to stick with a traditional 30 year loan. Ask yourself as well if there are other things you could do each month with the extra $400 such as save for a child’s college fund, pay off existing debt, or invest for retirement.
Ultimately, only you can decide which mortgage is right for you; however, be sure to discuss the options with your mortgage lender and real estate agent for more information before making a final decision. Just to get you started, click here and here for some more resources that will help you understand your home financing options.