Housing & Mortgage
Said No to a 15-year Mortgage? Think Again
A home loan should fit your financial plan, not vice versa
Fewer than one in 10 home buyers chooses a 15-year fixed rate mortgage. It’s not hard to see why. Sign up for a 15-year loan and your monthly payments are going to be nearly double what you’d owe with a more forgiving 30-year fixed rate loan.
But the 15-year deserves serious consideration for any household eager to build financial security and flexibility. To be clear, a 15-year isn’t going to work for everyone, but for some households the knee-jerk decision to just go with the popular 30-year is short-sighted.
What you gain with a 15-year fixed rate mortgage
The big potential payoff with a 15-year is flexibility. Consider a few scenarios:
If you are in your 30s when you buy your house, and go with a 30-year mortgage you will still be paying the mortgage in the employment danger zone of your late 50s and 60s. The harsh reality is that many people end up being downsized in their 50s and often don’t make as much in their next job.
Take out a 15-year mortgage in your 30s or early 40s and you will be mortgage free as you navigate the older-employee years.
Or let’s consider the financial Mount Everest of raising kids. Take out a 15-year mortgage when the kids are young, and you could be mortgage free as they are ready for college. That frees up a lot of cash flow to help pay for school, if that’s a priority.
A 15-year fixed rate also helps you build up more equity a whole lot faster. With a 30-year, the first 10 years are mostly about paying the lender gobs of interest. After 10 years you’ve only whittled the principal down by 20%.
And if you care about the big picture, a 15-year will sharply reduce the total interest payments over the life of the loan. You also typically get an interest rate that is between 0.50 and 0.75 percentage points below the 30-year rate. In early 2019, the average 15-year fixed rate was 4.06%, compared to 4.62% for a 30-year. Using those recent rates, if you take out a $400,000 mortgage over 30 years, your total interest costs will be $340,000. Take out a 15-year fixed rate and your total interest cost will be $135,000.
The big honking trade-off
Of course, a 15-year is going to be a much bigger claim on your monthly cash flow. Using our $400,000 mortgage at recent rates, the 30-year will cost you about $2,055 per month in principal and interest. The 15-year will cost $2,970 per month.
That’s no small difference. But given the long-term payoff, it is worth it to at least think through if you might be able to afford it.
To be clear, a 15-year makes no sense if you will eat into emergency savings, run up credit card debt or slow down on your retirement savings. It’s also not a wise way to go if you work in a field that is prone to downsizing during recessions.
The only scenario where a 15-year should be contemplated is if you in fact have the cash flow -- or could have the cash flow. Comb through your bank and credit card statements and see if lifestyle creep is eating up a too-big chunk of your cash flow. For example, exactly how much are you spending on meals out? And are you paying $500 or more a month for a car payment? You get the idea. If you are intrigued by the 15-year, there may be a lot of give in your current spending habits.
Or reduce your target home price. For example, if you bought a house that required “just” a $325,000 mortgage –rather than the $400,000 example above – your monthly cost will fall from $2,970 to around $2,650.
If, once you crunch the numbers, you’re not sure you can pull it off, take that as a signal that you’re either buying too expensive a house, or the 30-year is indeed your best option. Stretching to afford a 15-year is a recipe for anxiety and, potentially, financial problems.