When you plan to buy a house, a 15-year fixed-rate mortgage can be a better option than a 30-year mortgage because you will pay less in interest charges and private mortgage insurance premiums through the lifetime of your mortgage, and your home will be yours much quicker.
What Is a 15-Year Fixed-Rate Mortgage?
15 years to repay your mortgage
A 15-year loan term means that it will take you 15 years to repay the full amount you borrowed plus the amount of interest charges.
Fixed mortgage rate
In comparison with an adjustable rate, a fixed interest rate will not change throughout the lifetime of the mortgage loan. From day one until the last monthly payment, the interest you pay for borrowing the money will be the same. This is one of the factors to consider if you are on a tight monthly budget and wish to know what payments to expect every month.
Benefits of 15-Year Fixed-Rate Mortgage
Long-term savings
The greatest benefit of a 15-year mortgage is that, although monthly payments are higher, you gain from long-term savings. You pay less in interest and you repay your mortgage faster. That means that overall, you save money in the long run.
Let’s take an example. Let’s say you borrow $300,000 for a home. Let’s assume that the interest rate is the same for a 15-year mortgage and a 30-year one although we do know that it will be lower for the shorter timeframe.
The current APR is around 7.05%, but let’s assume your credit score is stellar and you can get a mortgage at 6.8%.
For a 15-year mortgage, you will pay $143,479 plus the capital.
If you extend the mortgage to 30 years, mortgage interest climbs to $323,263, which is $179,784 more in interest charges.
With a 15-year mortgage, you will save a significant amount in total principal and interest.
If you can afford the higher monthly payments, a 15-year mortgage is a financially savvy choice that will save you money and allow for faster mortgage amortization.
Lower interest charges and homeowners insurance
The bottom line is that a 15-year fixed-rate mortgage can save you thousands of dollars in the long term. That’s because the lower the time period you borrow money, the lower the interest rate. Loan rates for 15-year-long mortgages are lower than interest rates for 30-year-long ones, even if it’s by a small percentage such as 0.5%.
While a 0.5% difference might not seem a lot at first sight, when you compound that over many years, the total cost you save and the benefit for your financial situation is significant.
For example, let’s say you borrow $300,000 for a property with an interest rate of 5.1%. You will spend in interest charges throughout the lifetime of the mortgage a total value of $103,877. Now let’s say the interest rate is 5.5%. In this case, interest payments will climb to a total loan amount of $112,980 — a difference of almost $10,000.
Building equity faster
A shorter mortgage allows you to build equity faster. 15-year fixed-rate mortgage loans repay the loan faster than 30 years. Remember that when you borrow for a mortgage, initial payments repay the interest rather than the principal balance. With a 15-year fixed-rate mortgage you start repaying the capital principal faster.
When you build equity faster, you can tap it if you need extra liquidity for a college fund or a financial emergency. It gives you breathing space to allocate this equity to other financial goals or needs. Likewise, if you plan to sell or refinance your home, building up equity earlier will be helpful.
Financial discipline
By committing to higher payments, home buyers are effectively prioritizing their mortgage process over other less essential expenditures. This is the quickest path to becoming mortgage-free.
This disciplined approach to financial planning can have long-term benefits, including the freedom and security that come with owning real estate outright sooner.
Your home loan is paid off sooner
A 15-year mortgage is repaid sooner. You are mortgage-free within 15 years so you can repurpose money towards other needs such as additional retirement funds, student loans, savings accounts, home improvements, or even a new auto loan or holidays.
Shorter repayment periods provide a buffer against money market fluctuations and increase the homeowner’s net worth. They also open up options such as leveraging equity for home improvements or other investments.
Whether you plan to live in your home for a longer period or you wish to purchase an investment property, this fast build-up of home equity can be particularly helpful.
Potential Challenges of a 15-Year Fixed-Rate Mortgage
The biggest challenge of a 15-year fixed-rate mortgage is that you must allocate a larger percentage of your monthly income toward the mortgage monthly payment.
The higher monthly payment can be a significant burden, especially for those with fluctuating or uncertain income. This lack of flexibility can lead to financial strain in times of unexpected expenses or income disruptions. For example, if there is a health emergency or an urgent home repair needed, or if the cost of living goes up significantly, these can squeeze finances.
Additionally, by allocating a larger portion of your balance to mortgage payments, there may be less money available for other investments, savings, or spending on lifestyle and leisure activities. Financial discipline comes at a cost.
Frequently Asked Questions
What are the main differences between a 15-year and a 30-year fixed-rate mortgage?
A 15-year mortgage will have larger monthly payments but lower overall interest costs, while a 30-year mortgage offers lower monthly payments but higher interest rates.
Are the interest rates for 15-year mortgages typically lower than for 30-year mortgages?
Yes, mortgage lenders generally offer lower mortgage rates for 15-year mortgage loans compared to 30-year mortgages. This is because a shorter loan term is associated with less risk for the mortgage lender.
How does a 15-year mortgage impact my overall financial planning?
A 15-year mortgage with higher monthly payments will significantly impact your budget due to the higher payment each month. It requires careful financial planning and might limit your ability to allocate funds to discretionary spending, savings, some other investment, or repaying other debt such as credit cards and personal loans.
Is there a way to combine the advantages of both the 15-year and the 30-year fixed-rate home loans?
A strategy combining both loans, which allows you to combine and balance their pros and cons, consists of buying a home with a 30-year fixed loan (which has a higher interest rate but allows for an affordable monthly mortgage payment), then down the line, toward the 15th year of the loan, refinancing to a 15-year fixed-rate mortgage loan with a lower interest rate. With a loan refinance, borrowers benefit from the 30-year mortgage’s lower monthly payment, but also from a lower rate after the first half of the loan duration.
