If you're thinking about buying a new home or refinancing your current home loan, one big thing you're probably contemplating is your mortgage term. So, what's better, a 15- or 30-year mortgage plan?
Unfortunately, there's no right answer.
There are pros and cons to both, but the secret to making the right decision is understanding your budget and financial needs.
"A lot of people are saying, 'I'd like to pay off my mortgage, I'd like to be debt-free, I'd like to take advantage of a lower percentage rate,'" says Fred Arnold, a mortgage professional in Southern California and a former president of the California Association of Mortgage Professionals. "But on the other side someone is saying, 'I just need a $300 break each month because I've lost $500 in overtime.'"
So, depending on your financial situation, there are pros and cons to both a 15- and 30-year mortgage. To help you make a more informed decision, we've spoken to mortgage experts to help highlight the ups and downs of each loan type.
Keep reading to learn more...
Short-Term Loan (15 years)
Paying Down Your Loan Faster: "We have seen a jump in the 15-year fixed-rate mortgages as more Americans choose to pay down their debts," says Matthew J. Robinson, senior public affairs specialist at the Mortgage Bankers Association in Washington, D.C. "With interest rates as low as they are the monthly payment difference can be minimal."
Arnold agrees."There's a trend now of people wanting to pay off their mortgages that we haven't seen since the Greatest Generation," he says.
Arnold adds that families who can afford the higher 15-year mortgage payment choose it so that they can own their homes sooner and avoid the pressure of payments if hard economic times are ahead.
"People are thinking, 'I don't know what's going to happen next, but I know they can't take away my home,'" he says.
Lower Interest Rate: "Shorter-term mortgages -for example, a 15-year mortgage instead of a 30-year mortgage - generally have lower interest rates," notes a mortgage refinancing guide by the Federal Reserve, which oversees national monetary policy and the banks.
Arnold says lenders offer a lower rate because they know you will pay it back sooner.
"It's a new goal," he says. "The new mentality of the consumer is, 'Let's get ourselves into a better financial picture.' A lot of people see this as a tremendous opportunity to get into a situation so that when they retire they'll have minimal debt on their house or none."
He adds that the 15-year payments force people to spend their extra cash on their home and thus pay it off sooner and with less interest.
Higher Monthly Payments: The drawback to a 15-year loan for some consumers is that the payments will naturally be higher whereas payments stretched out over 30 years will be lower. This is typically the factor that determines which type of loan the homeowners will choose.
"You have to make sure you have the ability to repay and know where that payment is going to fit into your budget," said Donald J. Frommeyer, president of the National Association of Mortgage Professionals. "If the house is in the $200,000s, that payment is going to be quite a bit more than what it would be if it were a 30-year mortgage."
If you can't afford a 15-year loan right away, Frommeyer recommends starting off with a 30-year mortgage with the goal of refinancing (replacing the current loan with one that has different terms) later on.
"It's so much better if you can do a 15- or even a 10-year loan because of the savings you're going to get," says Frommeyer.
Long-Term Loan (30 years)
So if everyone agrees that a 15-year mortgage pays down principal sooner and costs less in interest, are there any reasons to even consider a 30-year plan that will last longer and cost more? Plenty, it turns out.
Lower Monthly Payments: "Some people just don't have the financial resources to make the higher payment," Arnold says, "so the 30-year fixed-rate mortgage has been a tremendous saving grace to them. It allows them to drop their payment and get their financial house a little bit in order."
He says people who are approaching retirement might want a lower payment so they can have more spendable cash. Others who may benefit from lower payments include people who have lost their job, or self-employed individuals whose business has dropped.
If you're thinking about refinancing, for example, Arnold says "The 30-year loan allows people to reset to a lower payment to get them through tough times. To some, it might mean the difference between keeping their home and not keeping their home, or the difference between having a lot of stress and breathing easier."
Extra Cash for Investments: Another positive of a 30-year mortgage, says Arnold, is that a lower mortgage payment allows consumers to put any extra money they have into a 401(k) or IRA each month. If there's still money leftover, they can use it to make additional principal payments and still pay off their home sooner.
Inflation Agrees with a 30-Year Mortgage: There's one more reason a 30-year mortgage might turn out to be more desirable than a 15-year mortgage, says Ty Bernicke, a certified financial planner and principal at Bernicke and Associates in Eau Claire, Wis.
"One of the biggest concerns economists have is inflation taking off," he says. "If that happens, it's good to have a fixed-rate 30-year mortgage because you'll be paying back the loan with diluted money - money that buys a lot now but won't in the future. The people who benefit during inflation are the ones who owe someone else money."
Years of Accrued Interest: The main reason to avoid 30-year loans, if possible, is that you'll end up paying a lot more in interest, and thus causing a home to cost much more than its selling price. What's more, for the first few years, your payments will be going primarily to interest.
And while you'll be able to write off your interest payments on your taxes, Arnold points out that the amount drops off as the interest is paid down.
When it comes to choosing the right loan term for you, the pros agree that there's not one answer to fit everyone. The key is to examine your own situation - your earning potential, as well as your short-term needs and long-term goals. Once you've assessed your needs, then you can decide which solution is right for you.