Lenders offer several types of mortgages, but the most popular are fixed-rate mortgages. These loans feature fixed rates and monthly payments, generally for 15- and 30-year periods. They're popular because most borrowers balk at the thought of their house payment rising and falling with interest rates. Whenever rates are low, fixed-rate mortgages are very affordable.
Fixed-rate loan borrowers face one major choice: 15 years or 30? For some, a 30-year loan makes more sense. For others, owning the home in just 15 years is more attractive. Here are some pros and cons of each.
Offers the chance to borrow money over a very long time, keeping payments low. The fixed rate means you don’t have to worry about the interest rate or payment changing.
Monthly payments are lower than those on 15-year loans because the loan balance is spread over a longer period.
Lower monthly payments free up money that borrowers can pour into investments that yield more than their homes, like retirement accounts. Higher interest increases the amount consumers can deduct at tax time, potentially reducing or eliminating their federal income tax liabilities.
Borrowers build equity at a very slow pace because payments during the first several years go largely toward interest rather than principal.
The total interest paid (TIP) is much higher than with a 15-year term.
Interest rates are higher for 30-year terms than on 15-year terms.
Borrowers build equity much more quickly due to the shorter term.
Total interest paid is dramatically lower than that of longer-term loans.
The interest rates are lower than 30-year loans.
Monthly payments on a 15-year loan can be significantly higher (although not double) the payments of 30-year loans.
Restricts homebuyers to smaller houses than they might be able to afford with longer-term loans.
When choosing between 15- and 30-year terms, keep in mind that there are ways to prepay your mortgage and whittle away at the principal each month, so that the loan is paid off sooner than 30 years. The power of an extra $100 a month is undeniable. A 30-year loan can shrink to, say, 22 years, and you save a lot in total interest.
Also, when it comes to choosing between fixed-rate mortgages and adjustable-rate mortgages (ARMs), how long you plan to stay in the home matters. If you plan to live there less than five years, you may be better off with an adjustable-rate mortgage. We talk about ARMs in our next chapter.