Should You Choose a 15-Year or 30-Year Mortgage?
When buying a home, one of the most critical financial decisions you’ll face is choosing between a 15-year and a 30-year mortgage. This choice not only determines your monthly payment but also impacts the total interest you’ll pay over the life of the loan. Historically, 15-year mortgages have offered lower interest rates, averaging 0.55% less than 30-year mortgages over the past 30 years, according to Freddie Mac.
Despite this advantage, at Mills Wealth, we often lean toward recommending a 30-year mortgage. The main reason for this is that it provides lower monthly payments, greater financial flexibility, and the ability to pay off the loan in 15 years through strategic overpayments if desired. Let’s explore the factors that influence this decision and why, for most people, the 30-year mortgage is often the better choice.
Interest Rates and Lifetime Costs
A 15-year mortgage typically comes with a lower interest rate than a 30-year mortgage. This lower rate means less interest accrues over time, reducing the total cost of borrowing. For example, on a $500,000 loan:
- 15-Year Mortgage at 6.45%: Total interest paid would be approximately $264,000.
- 30-Year Mortgage at 7.00%: Total interest paid would be about $697,000.
The difference in total interest is substantial: the shorter term and lower rate of the 15-year loan result in significant savings over the life of the loan. However most of this is due to the extra 15-years of the payment. If you were to make the same payment as you did on the 15 year the total interest charged during the first 15 years would be approximately $330,468, it it would only take 1 extra year to pay it off.
Monthly Payment Amounts
Those savings come at the cost of higher monthly payments. Using the same $500,000 loan:
- 15-Year Mortgage at 6.45%: Monthly payment is about $4,337.
- 30-Year Mortgage at 7.00%: Monthly payment is approximately $3,327.
That’s a $1,010 difference each month. For many families, this higher payment on a 15-year loan can strain the household budget and reduce financial flexibility.
Flexibility of a 30-Year Mortgage
One of the main advantages of a 30-year mortgage is its flexibility. The lower monthly payments provide breathing room for other financial priorities, such as building an emergency fund, paying down high-interest debt, or contributing to retirement accounts or other investments. With a 30-year mortgage, you’re not locked into a higher payment. If you have extra funds, you can always make additional principal payments to reduce the loan term, effectively turning your 30-year mortgage into a 15-year schedule. However, if financial challenges arise, you have the option to stick with the lower required payment.
The Power of Overpayments
Let’s say you take out a 30-year mortgage but decide to make additional payments to match the monthly amount of a 15-year loan. Using the $500,000 loan example at 7%:
- By paying $4,337 a month (instead of $3,327), you could pay off the loan in about 16 years.
- You still benefit from the flexibility to revert to lower payments if needed.
This strategy allows you to mimic the benefits of a 15-year mortgage while retaining the safety net of a 30-year loan. It’s a win-win scenario for those who want to balance financial discipline with adaptability.
Opportunity Cost: Investing the Difference
A major consideration is what you could do with the money saved on a 30-year mortgage’s lower monthly payments. For example, if you save $1,010 a month (the difference between the two loan types) and invest it at an average annual return of 8%, you could amass significant wealth over time. After 15 years, that investment could grow to nearly $375,000. This strategy assumes discipline and the ability to tolerate investment risk. However, the potential to grow wealth faster than the interest saved on a 15-year mortgage is a compelling argument for many.
And if you invest the $1,010 every month at an 8% annual return for 30 years, the investment would grow to approximately $1,515,298 after the 30 year mortgage.
The number is quite similar if you wait to invest the $4,337 until after its paid off in year 15. If you invest $4,337 every month at an 8% annual return for 15 years, the investment would grow to approximately $1,510,773.
Risk and Income Variability
A 30-year mortgage also provides a cushion for those with variable incomes or unpredictable expenses. If you’re a business owner, freelancer, or early in your career, the flexibility to pay less during lean months can prevent financial stress. In contrast, the higher fixed payments of a 15-year loan leave little room for error if your financial situation changes unexpectedly.
Psychological Considerations
Some people prefer a 15-year mortgage for the peace of mind it brings. Paying off a home in half the time provides a sense of accomplishment and security, especially for those nearing retirement. A 15-year loan forces you to build equity quickly, eliminating the temptation to spend extra cash elsewhere. However, the rigidity of a 15-year mortgage can also create stress if unexpected expenses arise. The flexibility of a 30-year loan often outweighs the psychological benefit of being debt-free sooner.
Who Should Choose a 15-Year Mortgage?
A 15-year mortgage may be the right choice if you:
- Have a high, stable income that comfortably covers the higher monthly payments.
- Are focused on minimizing lifetime interest costs.
- Want to build equity rapidly and pay off your home before retirement.
- Have little to no other debt and a robust emergency fund.
If your financial situation aligns with these factors, the lower interest rate and shorter term of a 15-year mortgage can save you a significant amount in interest.
Why We Typically Recommend a 30-Year Mortgage
At Mills Wealth, we generally lean toward recommending a 30-year mortgage because of its:
- Lower Monthly Payments: This reduces financial strain and increases cash flow for other priorities.
- Greater Flexibility: The option to overpay or revert to lower payments allows adaptability to changing circumstances.
- Investment Opportunities: Saving and investing the difference in payments can yield higher returns than the mortgage interest rate.
- Reduced Risk: Lower required payments minimize the risk of default during financial downturns.
A Balanced Approach
For most clients, a 30-year mortgage offers the best of both worlds. Here’s how:
- Opt for a 30-year mortgage to secure lower payments.
- Ability to make extra principal payments when possible to shorten the loan term.
- Use the cash flow flexibility to invest or prioritize other financial goals.
Conclusion: It Depends
Choosing between a 15-year and 30-year mortgage depends on your financial priorities, risk tolerance, and goals. While a 15-year mortgage provides lower interest rates and significant savings over time, the higher payments can limit flexibility. At Mills Wealth, we typically recommend a 30-year mortgage because it combines the flexibility of lower payments with the option to pay off the loan faster if desired. By balancing cash flow, financial goals, and discipline, you can make either option work to your advantage. As with any major financial decision, consult a trusted advisor to weigh the trade-offs and choose the mortgage that aligns best with your financial future.