Choosing a home is only one step in the purchasing process – there are many decisions you must make along the way, like whether to get a 15-year mortgage or a 30-year one. There is no right answer – both have pros and cons. The right answer is simply what’s right for you.
The Term and What You Really Pay
A 15-year term allows you to pay off your home quicker; the balance shrinks faster, which results in you paying off more principle with less interest. A 30-year term, on the other hand, results in you borrowing for twice as long. The balance doesn’t shrink as quickly and you end up paying off less principle with more interest. A 30-year term does offer better tax breaks, but compared to the interest, they’re too negligible to be much of a factor.
According to Investopedia, a buyer who opts for a 30-year term at a rate of 4% ends up paying 2.2 times more interest than one who opts for a 15-year term. A 15-year term is much more affordable, not only because you pay off your balance faster, but also because the interest rate is lower. It’s less risky for a bank to lend you money for 15 years than it is for them to lend you money for 30 years; they reward this reduced risk with a reduced interest rate.
This makes the choice appear obvious: a 15-year term is better for your finances. But is it really the way to go? It depends on what you can afford.
While a 15-year term results in less interest and a cheaper home overall, the monthly payment is much higher, typically several hundreds of dollars higher. Not all home owners can afford this; some don’t have the ability to pay a higher monthly rate and some prefer not to. They’d rather put their extra savings into a nest egg or use it for other things.
For anyone considering a 15-year term, it’s recommended that they already have savings accrued. These savings act as an emergency fund in the event it becomes difficult to pay the mortgage. If you don’t have savings, a 30-year term may be a wiser option – taking longer to pay off your home is better than finding yourself in a situation where you can’t pay for it at all.
The Best of Both Worlds
There is middle-ground between the 15-year term and the 30-year term (and, no, it’s not a 22.5-year term). Some people opt to take a 30-year term and make higher-than-required payments. This is a best of both worlds scenario. You’re not locked into a 15-year term that can leave you financially strapped, but there’s no guarantee that you’ll be saddled with loads of interest, either. Rather, you pay greater amounts when you can. If you get a bonus or a promotion, sell property, or come into cash unexpectedly, you can funnel that money into your home.
Everything about the home buying process, from what you’re looking for in a house to the mortgage, is individually based. A term that works for others may or may not work for you. It really comes down to your financial standing and what you can comfortably pay each month.
If you’re moving to Seattle and the surrounding areas, get in touch with us. We can answer any questions you may have about mortgage terms and the housing market.