Mortgages are a big commitment that homeowners assume to secure probably the biggest asset they will ever have. Traditionally, lenders offered the 30 year mortgage to borrowers as a means to secure their dream homes. Then, in the new millenium, lenders have created more borrowing options for homebuyers. Lenders have offered fixed-rate terms with maturity dates as low as 5-, 10-, and 15-years.

In this article, we are going to look at the 30 year loan and the 15 year loan to compare them against specific loan attributes to help readers determine which loan is right for them.

30 Year Mortgage

With a 30-year mortgage, which is the more traditional loan type than the 15-, 10-, or 5-year mortgage, borrowers pay back the loan over a 30-year period of time.

15 Year Mortgage

With a 15-year mortgage, the borrower pays back the loan over a 15-year period of time.

Scenario

For comparison purposes, we will use the following scenario to compare each loan type.

Home price: $200,000
Interest rate: 3% (30 year); 1.5% (15 year)
*ASSUMPTION: The borrower is paying back the loan as defined by the loan terms.
**NOTE: Taxes and Insurance are not being taken into consideration. Only principal and interest.

Key Attributes

Interest rate: As we revealed in the scenario above, the interest rate on a shorter-term loan, such as the 15-year mortgage, would be lower than the interest rate on a longer-term loan like the 30-year mortgage. This is because the bank is incentivizing the borrower for committing to a shorter term loan. With a lower interest rate, the overall purchase of a $200,000 property would be cheaper with a 15-year loan as opposed to a 30-year loan - assuming the borrower is making only the stated monthly payments as outlined by the loan terms. All things being equal, we used Bankrate’s True Cost of a Loan calculator. Using the scenario above, a borrower with a 30 year loan would pay $303,554.90 over the life of the loan; whereas, a borrower with a 15 year loan would pay $223,467.49. That is a difference of $80,087.41.

Monthly payments: Being as though the 30-year mortgage allows the borrower to stretch out the loan over a longer period of time, the 30 year mortgage’s monthly payments - assuming the borrower is abiding by the terms of the loan - are going to be lower than the 15 year mortgage. Again, using Bankrate’s True Cost of a Loan calculator, the monthly payments on a 30 year mortgage in our scenario would be $843.21 as opposed to $1,241.49 for a 15 year mortgage. A 30 year mortgage would save a borrower $398.28 per month.

Home affordability: A lower monthly payment may allow a borrower to assume a larger mortgage. As a result, the 30 year mortgage may be more beneficial as it reduces the monthly payment obligation of the borrower. For example, using the scenario above, some borrowers desiring a 15 year mortgage may not be able to afford the $1,241.49 monthly payments associated with it. Consequently, they may have to seek properties for sale in a lower range ($125,000 to $150,000), which would limit the borrower’s options. The borrower may be confined to less desirable locations, smaller dwellings, or properties that need fixes and updates.

Bigger tax write-off: If a borrower is looking for a tax shelter, the 30 year loan has the bigger advantage over the 15 year loan. With the 30 year loan, most of your payments, in the initial years of the loan, go towards the interest; whereas, with the 15 year loan, most of your payments are applied to the principal. As a result, one would have a bigger tax write-off with the 30 year loan as opposed to the 15 year loan.

Repayment period: A 15 year loan has a shorter loan period than a 30 year loan. Borrowers looking to pay off a loan faster may have an advantage with the 15 year loan over the 30 year loan.

Flexibility: A 30 year loan is more flexible than a 15 year loan. In the scenarios above, we are assuming that the borrower under either scenario is abiding by the loan terms and is not paying any additional monies towards the principle of the loan. However, there are no legal statutes blocking borrowers from paying off any loan, be it a 15 year or 30 year loan, ahead of schedule. As a result, the 30 year loan appears to be more flexible. Using our scenario, the borrower has 30 years to pay back $200,000 and the bank states they must pay, at a minimum, $843.21. However, the borrower could pay any amount over $843.21 to expedite the loan payoff process. The borrower could even choose to pay back the loan in 15, or even 5 years, if they are ready, willing, and able to do so. But the borrower under the 15 year loan has more restrictions. Yes, the 15 year loan borrower could pay back the loan in 15, 10 or 5 years, but they cannot pay the loan back in 16 years or more. The 30 year borrower has more cushion for error.

Summary

Both loan types have their own benefits. Borrowers should analyze their specific situations and decide which is the best option while keeping their personal constraints and financial behaviors in mind.

Borrowers should consider how long they plan to stay in the home as a major factor before selecting the loan type. Similarly, borrowers should also consider if building equity quickly is a major driver for them as well.