Buying a home comes with a hundred decisions, large and small. More than a few of them surround the mortgage you use to pay for it.
Among those decisions? The loan term you want.
As you talk to mortgage lenders about financing your next home, consider the following pros and cons for 15-year versus 30-year mortgages.
Pros of 15-Year Mortgages
While some of the advantages of a 15-year mortgage seem obvious, the implications often aren’t.
Starting from the assumption that you choose either a 15- or 30-year fixed-interest loan, rather than more niche loans like a balloon mortgage — which is not a good fit for most homebuyers — keep these advantages of a shorter loan term in mind.
Shorter Debt Horizon
No one likes debts hanging around their necks. Beyond the interest and costs, it adds a source of stress for many borrowers.
Paying off your mortgage faster means a shorter horizon for becoming debt-free. Some personal finance experts, such as Dave Ramsey, urge people to pay off their home mortgage debt before focusing on building wealth.
Shorter-term loans often make sense for those planning for retirement. The lower your living expenses in retirement, the less you need to draw from your investments. And paying off debts before retirement is one of the easiest ways to reduce risk as a retiree. So, as a 50-year-old planning to retire at 65, a 15-year loan would eliminate your mortgage payment just in time for retirement.
Build Equity Faster
Sure, building equity in your home feels nice. But it also comes with several tangible benefits.
First, you can eliminate private mortgage insurance (PMI) faster, if you took out a conforming loan rather than an FHA loan. Conforming loans allow you to apply to remove PMI once you pay down your balance below 80% of your home’s value, which in turn saves you money every month.
Building home equity faster also gives you more flexibility to move and sell your home without having to cough up money at the settlement table. When you buy a home, you take an initial loss, paying thousands of dollars in closing costs. When you sell a home, you take another loss, paying thousands more in real estate agent fees and seller closing costs.
Equity in your home buffers you against having to come up with extra cash out of pocket to cover these costs when you sell. Which in turn reduces the risk of feeling trapped and unable to move, should the need or desire arise.
Lower Interest Rate
Mortgage lenders charge lower interest rates for shorter-term loans.
They do so because the faster you pay down the loan balance, the less risk they incur. Imagine two identical homeowners each lose their job and default on their loan after five years. A borrower with a 15-year loan would be much further along in paying down the balance than an identical borrower with a 30-year mortgage. Thus, if the bank had to foreclose, they’d recover far more of their money with the 15-year loan borrower.
Lenders price loans based on risk. The lower the risk, the less they charge.
Lower Total Interest Paid
The lower interest rate aside, borrowers still pay more in interest for longer-term loans.
Consider an example with real numbers. Two borrowers take out loans for $300,000 at a 4.5% interest rate (never mind that a 15-year borrower would pay a lower rate in real life).
A 15-year borrower would pay $113,096 in total interest over the life of the loan. A 30-year borrower would pay $247,222 in total interest — a difference of $134,126, more than double the total interest paid.
Cons of a 15-Year Mortgage
If 15-year loans came with nothing but upsides, everyone would borrow them!
Higher Monthly Payments
The glaring, obvious difference between these two loan terms is the difference in monthly payment.
With a shorter-term loan, many borrowers just see getting less house for more money each month. Because when you’re talking about debt horizons in the decades, future savings over the life of the loan become conceptual and less real to the human mind. It all just blends together as “the distant future.”
But the higher monthly payment is very, very real right now.
Rigidity in Repayment
Borrowers must repay short-term loans faster. No exceptions, no flexibility: pay down the loan fast, or else.
Longer-term borrowers can choose to pay down the loan at a more flexible pace — more on that shortly.
Mortgage loans offer the cheapest interest of any loan type. Not only are they secured by real estate, but to default means literally losing the roof over your head. Borrowers don’t default lightly on their home mortgage. All of this means lower risk for lenders, and low interest rates.
Which means homeowners can borrow money so cheaply that they can earn a spread by investing it elsewhere.
By way of illustration, consider my parents in 2010. They received a windfall of money, and had a decision to make: they could pay off their mortgage in full, or they could invest the money.
They chose to pay off their mortgage because it was safe and easy and familiar. They saved themselves paying around 4% APR interest. If they’d invested that money in the S&P 500 instead, they’d have earned an annualized return of 11.83% over that period — nearly triple what they saved on mortgage interest.
In most cases, it makes financial sense to pay down debt as fast as possible. But mortgage loans are so cheap that it often makes more sense to leave them in place and invest your extra money elsewhere.
Pros of a 30-Year Mortgage
The pros and cons of 30-year mortgages reflect the inverse of those for 15-year loans.
Lower Monthly Payments
With a longer loan term, you get more house for less money — at least on a monthly payment basis. You’re more likely to be able to move into your dream home, today.
Or move into a better school district, in time for the coming school year.
Lower mandatory monthly mortgage payments also provide you with more flexibility.
Flexibility in Repayment Speed
With a 15-year term, you must repay it in full in a maximum of 15 years. The only way to extend the repayment period is to refinance, which is expensive.
But 30-year loans also let you pay off the loan in 15 years. Or 10 years, or 20, or 24 years, 10 months, and 27 days if you so choose.
If you have extra money in a given month, you can put it toward your principal balance. When the screws tighten, you can fall back to the mandatory minimum monthly payment.
Which raises an important point: 30-year home loans reduce your minimum living expenses, which is handy in emergencies such as a job loss. Likewise, lower living expenses means a smaller necessary emergency fund.
Flexibility to Invest Money Elsewhere
Homeowners can effectively earn a spread on low-interest loans like mortgages. If you borrow money for 3% interest and invest it for 10% returns, you earn a 7% spread on that money.
In other words, there’s no rush to repay low-interest loans if you can earn a higher return elsewhere. Paying off loans early pays you a return equivalent to the interest you would have paid on it.
I can think of many places I can invest money for a higher return than the interest rate I pay on my mortgage.
Cons of a 30-Year Mortgage
Just as the advantages of a 30-year loan reflect the opposite of 15-year mortgage downsides, so too with their cons.
Longer Debt Horizon
Who wants to take on a debt that lasts for the rest of your life? When I kick the bucket, I would just as soon leave my daughter with a free and clear home than one saddled with a heavy mortgage.
Actually, I’d prefer not to have any debt at all going into retirement. Less debt means a safer retirement, after all.
Just don’t let wily mortgage lenders trick you into refinancing to extend your debt horizon even further.
Slower Equity Gain
Paying down your mortgage more slowly means building equity more slowly.
Which in turn means paying PMI for longer, and a greater risk of becoming upside-down on your home. Lacking equity in your home can lead to feeling trapped and unable to move because Realtor fees and other seller settlement costs would force you to cough up money at the settlement table, rather than walking away with a check if you sold.
Higher Interest Rates
Lenders charge higher interest rates for longer loans. Period.
That means even if you plan to pay off your 30-year mortgage in 15 years, and simply want the added flexibility outlined above, you still pay a premium for that flexibility.
Higher Total Interest Paid
With longer loan terms come more total interest due.
And not just a little interest either. In the example above, the borrower pays more than double the total interest for a 30-year loan — $247,222 compared to $113,096 — for a $300,000 loan at 4.5% interest.
How to Decide Which Is Right for You
Before choosing a loan term, consider your current needs and your long-term financial goals. For instance, if you plan to retire in the next 15 years and you wish to eliminate your mortgage before retiring, that makes an excellent reason to take out a 15-year loan.
Or your priority may be buying your first home or moving into a better school district for your children as soon as possible. In which case you might only be able to afford it with the lower payments of a 30-year loan.
With 30-year mortgages, you get low monthly payments and the flexibility to pay off your balance more slowly. But you pay for it in higher interest, slower equity gain, and a far longer debt horizon.
As a final thought, if you itemize your deductions and plan on taking the mortgage interest deduction, the higher interest of a 30-year loan may not bother you as much. But far fewer Americans itemize in the wake of the Tax Cuts and Jobs Act of 2017, which made the standard deduction much larger.
Mortgage lenders, family, and well-meaning friends all throw advice at you about the best mortgage term. Ignore them all.
Carefully review the pros and cons of both a 15-year and 30-year mortgage, and pick the one right for you and your priorities. Whichever you decide, opt for a fixed-rate mortgage unless you have very niche needs.
If you have any doubts about your ability to keep up with higher payments, choose the longer term.