When it comes to the great mortgage debate, I’ve already explained my position regarding 15- and 30-year loans: 30-year loans are better for a multitude of reasons. In fact, I think it’s a no-brainer.
I remember when I bought my first home in 1990, interest rates were in double-digit territory. Today, 30-year loans make more sense than ever with mortgage interest rates continuing to set new all-time lows. In fact, last week, a person with excellent credit could get a 30-year loan for rates as low as 3.375 percent and 15-year loans for an incredible 2.75 percent.
Enjoy it while you can, folks. Although it’s hard to believe, higher interest rates are inevitable.
One of the biggest advantages of the 30-year loan is its flexibility. After all, holders of 30-year loans can always make the extra payments required to pay them off in 15 years, should they choose to do so.
However, the poor guy with a 15-year note who suddenly gets laid off or runs into other unexpected financial difficulties, can’t reduce his payments in order to stretch that 15-year mortgage into a 30-year loan. Sure, he could try to refinance, but that can be difficult — especially for the unemployed.
Of course, the trade-off for having additional flexibility is higher interest payments.
Assuming a $200,000 loan, the impacts of those higher interest payments over time at today’s rates and can be seen in the following chart:
Obviously, folks with a 30-year mortgage are going to pay more interest, whether or not they make the extra payments required to retire their loan in roughly 15-years. Then again, how much more depends on how picky they are about getting the loan paid off in exactly 15 years.
In my example, a 30-year $200,000 mortgage at 3.375 percent results in a monthly payment of $884. Over 30 years, the home owner would end up paying $118,309 in interest to the lender — more than $70,000 compared to the 15-year loan at 2.750 percent.
However, for those who were truly serious about minimizing their interest costs by paying off that same 30-year loan in exactly 15 years, they could do so by increasing their monthly payments to $1424 (that’s $540 more than the minimum payment).
Over the life of the loan, that strategy would result in additional interest expenditures of only $10,491 compared to the 15-year mortgage. Spread out over 15 years, it’s a premium of just $58 per month. Not bad at all for those looking for the added peace of mind.
Alternatively, faithfully making monthly payments over the life of the loan equal to the 15-year mortgage at 2.75 percent ($1357) would result in slightly higher additional interest costs of $14,330. That’s a premium of $74 per month over the life of the loan, which would be a bit longer; in this case, 15 years 11 months.
So there you have it. Hopefully, this little example provides you with a bit more insight into just how much extra it currently costs to take on a 30-year loan over it’s 15-year cousin.
As you can see, no matter how you slice it, people who prefer the numerous advantages of a 30-year loan over a 15-year mortgage are always going to pay more interest.
But for those who are looking for the extra flexibility of a 30-year loan as a hedge against a sudden loss of income or the prospect of high inflation, the added premium is a relative bargain.
Photo Credit: James Thompson