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During the home-buying process, when it comes time to apply for a mortgage, the vast majority of Americans choose a 30-year fixed-rate loan, and it's easy to understand why. After all, you can afford a larger home and keep your payments relatively low with a longer loan term. However, there are some pretty compelling reasons to consider a 15-year mortgage for your next home, and the numbers behind the shorter loan term may surprise you.
Reasons to consider a 15-year mortgage
There are several benefits to using a 15-year mortgage, including...
Lower interest rate:15-year mortgage interest rates are significantly lower than what you can get for a 30-year. As of this writing, the national average rate for a 15-year mortgage was 3.24%, well below the 4.01% you can expect from a 30-year loan.
Less interest:Not only is the interest rate lower on a 15-year mortgage, but the faster amortization schedule means you'll pay a lot less interest over time than you would on a 30-year. Based on today's interest rates, here's the difference it would make on a $200,000 loan.
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Build equity faster:Because more of your payment goes toward the principal, a 15-year mortgage allows you to quickly build equity in your home. At the current mortgage rates, just 30% of your first payment on a 30-year loan is applied toward the principal, with the other 70% going toward interest. However, 62% of your first payment on a 15-year loan is principal repayment. And the difference gets even wider as time goes on.
Drawbacks to keep in mind
The most obvious drawback is that your monthly payment on a 15-year mortgage will be higher than a 30-year mortgage payment on the same home. If you buy a home and obtain a $200,000 mortgage, you can expect to pay about $450 more per month on a 15-year mortgage than a 30-year.
Another drawback is the amount of "house" you can afford to buy. Using the standard rule that your mortgage payment shouldn't be more than 28% of your total income, a family with annual household income of $75,000 could get approved for a mortgage payment of $1,750 per month, as long as their other debts weren't excessive. With a 30-year mortgage, this means that you could afford to buy a home worth approximately $341,000, assuming the national average cost of property taxes and insurance, and a 20% down payment. If you choose a 15-year mortgage, your affordability drops to $236,000.
While I never advocate buying a house at the top of your budget unless it's absolutely necessary, the affordability issue should be taken into consideration. However, if you can afford a house that meets your needs while using a 15-year mortgage, it's worth looking into.
The numbers speak for themselves
Let's say you're in the market for your first home, and you decide on a house that costs $150,000. With a 20% down payment, this means you'll need to obtain a mortgage for $120,000.
A standard 30-year mortgage would result in a $573.59 monthly payment for principal and interest, and over the life of the loan, you'll end up paying $206,492 -- $86,492 in interest. On the other hand, while a 15-year mortgage would result in a higher $842.62 payment, your total interest cost would plunge to just $31,671.
In other words, while your monthly payment would be 47% higher, you'll pay off your house twice as fast and pay 63% less interest.
If you can afford it, it's definitely worth considering
On a personal note, when my wife and I bought our first home a few years ago, we decided to buy a house that was well within our financial comfort zone and finance it with a 15-year mortgage, a decision that served us well. Because of the accelerated principal repayment, after just a few years, we had built up enough equity that we were in a position to sell the home and put a down payment on our "forever" house.
I highly recommend 15-year mortgages for younger buyers in particular, as it is a smart way to build equity at a time in your life when it's extremely important to make wise financial decisions. Limiting your home search to what you can afford with a 15-year mortgage may seem like a sacrifice in the meantime, and it is, but it is a sacrifice that can pay off tremendously in the long run.
The article How to Save Thousands During the Home-Buying Process originally appeared on Fool.com.
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