Today’s mortgage match-up: “15-Year Fixed vs. 30-year Fixed.”
It’s that time again, where I take a look at a pair of popular mortgage programs to determine which may better suit certain situations.
Let’s compare the 15-year fixed mortgage to the 30-year fixed mortgage, two of the most commonly utilized mortgage products available to homeowners.
They are very similar to one another in the way they function (both are fixed), but one is paid off in half the amount of time. That can amount to some serious cost differences and financial outcomes.
While it’s impossible to universally choose one over the other, we can certainly highlight some of the benefits and drawbacks of each.
15-Year Fixed Mortgages Aren’t Nearly as Popular
The 30-year fixed mortgage is easily the most popular loan program available today. Around 70% of all mortgages are 30-year fixed products, whereas the percentage of mortgages that are 15-year fixed loans is roughly 15%.
Over time this number can fluctuate, but this should give you a good idea of how many borrowers go with a 30-year vs. 15-year mortgage.
If we drill down further, about 90% of purchase mortgages are 30-year fixed loans, and just about six percent are 15-year fixed loans. But why?
Well, the simplest answer is that the 30-year is cheaper, much cheaper than the 15-year, because you get twice as long to pay it off.
And the 30-year fixed never adjusts for that entire duration, making it one of the most simple and straightforward loan programs out there.
In short, it’s safe and easy to wrap one’s head around, not to mention affordable due to that long term, and as such very popular. This is why it’s heavily advertised and touted by most housing counselors and mortgage lenders alike.
With the 30-year, you can afford more house, which explains that 90% market share when it’s a purchase. The 15-year fixed market share is significantly higher on refinance mortgages because borrowers don’t want to restart the clock once they’ve already paid down their loan.
Despite the overwhelming popularity, there must be some drawbacks to the 30-yr, right? Of course there are…
15-Year Mortgage Rates Are Lower
First and foremost, you pay a premium for a 30-year fixed vs. a 15-year fixed in the form of a higher interest rate.
Put simply, because you get more time to pay off the mortgage, there is a cost associated. After all, lenders are agreeing to give you a fixed rate for double the amount of time, which is certainly a risk for them, especially if interest rates rise during that period.
For that reason, you’ll find that 15-year mortgage rates cost quite a bit less than those on a 30-year product. In fact, at the time this was written, mortgage rates on the 30-year fixed averaged 4.63% according to Freddie Mac, while the 15-year fixed stood at 3.82%.
That’s a difference of 0.81%, which is certainly very significant and should not be overlooked. So in general, you may find that 15-year mortgage rates are about 0.50% – 0.75% lower than 30-year fixed mortgage rates.
I charted 15-year fixed mortgage rates since 2000 using Freddie Mac annual averages, as seen above. Since that time, the lowest spread compared to the 30-year was 0.31% in 2007, and the highest spread was 0.88% in 2014.
In the year 2000, the 15-yr mortgage rate averaged 7.72%, while the 30-yr was a slightly higher 8.05%.
In 2016, these rates were 2.93% and 3.65%, respectively. So the 15-year has been enjoying a wider spread lately, though that could narrow over time.
But before you get ahead of yourself, know that the lower rate on the 15-year fixed comes with a higher monthly mortgage payment because you have 15 fewer years to pay it off.
Monthly Payments Are Higher on 15-Year Fixed Mortgages
On a $200,000 mortgage, which isn’t necessarily that large, the monthly mortgage payment would be $432.52 higher on the 15-year fixed mortgage because it’s paid off in half the amount of time.
So despite the lower interest rate on the 15-year fixed, the monthly payment is still significantly higher. Take a look at the numbers below, using those Freddie Mac average mortgage rates:
30-year fixed payment: $ 1,028.88 (for rate of 4.63%)
15-year fixed payment: $ 1,461.40 (for rate of 3.82%)
However, and this is the biggie; you would pay $170,396.80 in interest on the 30-year fixed mortgage over the full term, versus just $63,052.00 on the 15-year fixed mortgage!
That’s more than $100,000 in interest saved over the duration of the loan if you went with the 15-year fixed as opposed to the 30-year. Pretty substantial, eh.
You’d also build home equity a lot faster, as each monthly payment would allocate much more money to the principal loan balance.
But there’s another snag with the 15-year fixed mortgage option. It’s harder to qualify for because you’ll be making a much larger payment each month, meaning your DTI ratio might be too high as a result. So for some borrowers the 15-year won’t even be an option.
Most Homeowners Hold Their Mortgage for Just 5-10 Years
Now obviously nobody wants to pay an additional $100,000 in interest, but who says you will?
Most homeowners don’t see their mortgages out to term, either because they refinance, prepay, or sell and move.
So who knows if you’ll actually benefit long-term? You may have a well-thought-out plan that falls to pieces in 2-3 years, and those larger monthly mortgage payments could come back to bite you if you don’t have adequate savings.
What if you need to move and your home has depreciated? Or what if you take a pay cut or lose your job? Those larger mortgage payments will be more difficult, if not impossible, to meet each month.
And perhaps your money is better served elsewhere, such as in the stock market or tied up in another investment, one that’s more liquid, which earns a better return.
Make 15-Year Fixed Sized Payments on a 30-Year Mortgage
Even if you’re determined to pay off your mortgage, you could go with a 30-year fixed and make larger payments each month, with the excess going toward the principal balance.
This flexibility would protect you in periods where money was tight, and still knock several years off your mortgage, assuming larger payments were made fairly regularly. And there are always biweekly mortgage payments as well, which you may not even notice leaving your bank account.
In summary, mortgages are, ahem, a big deal, so make sure you compare plenty of scenarios and do lots of research (and math) before making a decision.
Most consumers don’t bother to put in much time, but planning now could mean far less headache and a lot more money later.
Pros of 30-Year Fixed Mortgages
- Lower monthly payment (more affordable)
- Easier to qualify
- Ability to buy “more house” with smaller payment
- Can always make prepayments if wanted
- Good for those looking to invest money elsewhere
Cons of 30-Year Fixed Mortgages
- Higher interest rate
- You pay a lot more interest
- You build equity very slowly
- If prices go down you could fall into an underwater quite easily
- Harder to refinance with little equity
- You won’t own your home outright for 30 years!
Pros of 15-Year Fixed Mortgages
- Lower interest rate
- Much less interest paid during loan term
- Build equity faster
- Own your home free and clear in half the time
- Good for those who are close to retirement and/or conservative investors
Cons of 15-Year Fixed Mortgages
- Higher payment makes it harder to qualify
- You may not be able to buy as much house
- You may become house poor (all your money locked up in the house)
- Could get a better return for your money elsewhere
Also see: 30-year fixed vs. ARM