15-Year Mortgage vs. Paying Off a 30-Year Mortgage Early: What’s Cheaper? | Mortgages

There’s a very good reason why so many Americans choose a 30-year fixed-rate mortgage. These longer-term loans provide smaller, more manageable monthly payments. However, interest rates on 15-year mortgages tend to be lower than those of 30-year loans. And you’re borrowing money for a shorter term, which means your total interest cost will be much lower over the life of your loan.

So, why do so few mortgage applicants choose a 15-year fixed loan?

“The disadvantages include higher monthly payments compared to a longer-term mortgage, which might strain a homeowner’s budget,” says Ken Lobo, a clinical assistant professor at Pace University’s Lubin School of Business.

“This can limit financial flexibility, making it harder to allocate funds for other expenses or investments. Furthermore,” Lobo says, “The commitment to a 15-year term may not be suitable for those who anticipate relocating or experiencing significant life changes.”

These two products are very similar and work pretty much the same way.

The most important difference is the one you already know. With a 30-year loan, you’re spreading payments over 360 months. While the 15-year loan requires just 180 monthly payments.

Let’s explore what that means in practice.

Whichever term you pick, you have to pay off your loan and the interest it accrues during the loan’s lifetime. With a fixed-rate loan, every principal and interest payment will be the same. But how those payments are applied to your account changes all the time.

In the first month of your mortgage, you owe a huge balance, and the interest accrued during the previous month takes up nearly your entire payment. But as your balance drops, less is required for interest and more goes toward reducing your mortgage balance. This process is called mortgage amortization. And your choice of a 15-year versus a 30-year mortgage makes a big difference in how quickly you build home equity.

Let’s compare the interest costs of a 15-year versus 30-year $200,000 mortgage. We’ll use the same 6% interest rate for each for the sake of example, although 15-year loans typically come with lower mortgage rates than 30-year loans.

So, by year 15, the interest due on a 15-year loan is only $643.19, compared to $8,712.07 on a 30-year loan. Meanwhile, the 15-year loan is nearly paid off, and the balance on the 30-year loan is still $142,097.98.

“A big advantage of a 15-year mortgage is that you’ll … save a lot on interest over the life of the loan because you’re borrowing for a shorter period and likely locking in a lower interest rate,” says Josh Green, a mortgage loan officer at Barrett Financial in Arizona. “Plus, you build equity much faster, which is great if you want to tap into that equity down the line for other financial goals.”

In the example above, you’d save $127,888.21 in total interest with the shorter-term loan. But your monthly payments would be $488.61 higher.

Here’s a different example for a larger, $400,000 mortgage.

You’ll note that payments on a 15-year mortgage are higher than on a 30-year loan. But, importantly, they’re not twice as much, even though you’re paying off the loan in half the time.

Private mortgage insurance, or PMI, is less costly with a 15-year loan than a 30-year loan. PMI is mandatory on most conventional loans when the down payment is less than 20% of the home’s purchase price. However, PMI premiums are lower if you have a 15-year loan.

A 15-year mortgage can be harder to qualify for than a 30-year loan. Often, the stumbling block is the borrower’s debt-to-income ratio, or DTI. This is one of the key affordability gauges lenders use.

You can calculate your DTI by adding up all your monthly debt obligations. This includes the monthly payments on your rent or mortgage, credit cards, installment loans, alimony, child support and more. It doesn’t include basic living costs like food or utilities.

Let’s say you earn $10,000 a month and you pay out $4,000 in debt obligations, including $2,200 for rent. Your DTI is 40%. And let’s imagine that you want to stop renting and take on a $400,000 mortgage. Replacing your $2,200 rent with a $2,398 mortgage payment pushes your DTI to 41.98%. But replacing it with a $3,375 15-year mortgage payment would give you a DTI of 51.75%.

You’ll struggle to find a lender that will approve your loan if your DTI is higher than 43%.

Shorter loan terms are less risky for lenders than longer terms, so they’re generally willing to charge lower rates for them. Typically, 15-year mortgage rates run 0.5 to 1 percentage point lower than rates for 30-year home loans.

That’s a 0.99 percentage point spread.

Given that difference in rates, let’s look at how much interest you’d pay with a 15-year mortgage versus a 30-year mortgage that you pay off in 15 years.

Even though both mortgages are paid off in 15 years, the 30-year loan costs over $38,378.87 more in interest. That is substantially more, especially when you consider the difference between the monthly payments is about $213.

By paying off a 30-year loan early, you can save a lot more in interest than you would if you took the full term, especially if you can do so in 15 years. With average mortgage sizes close to $400,000, you’re likely borrowing a huge sum. And the shorter the time you shoulder that burden, the less interest you’ll pay.

As importantly, you’ll be mortgage-free in half the time. And think what would follow: The investments you could make and the fun you could have without those monthly payments.

If you aim to pay off your loan within 15 years, why would you not get a 15-year loan? Well, there are some sound reasons.

A 15-year loan means committing to that higher monthly payment. Suppose your life changes: You get sick, or there’s another recession and you’re jobless for a while. The higher payment might suddenly become unaffordable.

Or maybe you work in the gig economy and face periods of famine and feast. A 30-year loan gives you more flexibility and extra room to maneuver in all these circumstances.

And, of course, you might have been left with no choice but to take a 30-year loan. Perhaps your DTI is too high to qualify for the shorter one.

Any of those could be legitimate reasons for choosing a 30-year loan. But the last example you read provided 35,000 reasons why a 15-year mortgage may be the better choice financially.