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Could The 30 Year Mortgage Be Detrimental To Your Financial Wellness
Could The 30-Year Mortgage Be Detrimental To Your Financial Wellness?
Which mortgage loan is best: the 15-year or 30-year? It’s one of the most common questions we receive in this business. Like many financial questions, it really depends on the circumstances of the individual.
Why 30 years?
Prior to the Great Depression, mortgages were shorter. To stimulate home buying, the
government agreed to back longer-term loans. The thinking on the 30-year loan was a
person would be able to pay off the loan over the course of their working years. While
many credit the 30-year mortgage with fueling the American dream of owning your own
home, we have seen a call for the end of the 30-year mortgage due to concerns about the
amount of interest consumers pay and recent abuses of the system, most notably during
the financial crisis. In most developed countries, 15-year mortgages are the standard.
The numbers tell the story.
The concern about the amount of interest paid on a 30-year mortgage is easy to see once
you enter it into a calculator. On a $260,000 30 year mortgage at 4%, the buyer would end
up paying more than $186,000 in interest over the life of the loan. Compare financing that
same amount using a 15-year mortgage at 3.75%. The total amount of interest paid drops
to $80,000. That is 57% less interest!
That same calculator also illustrates that much of the interest is paid in the earlier years of
the mortgage. This is especially important when you consider that most people will not live
in the same home for 30 years. If you make 2-3 home purchases over your lifetime and
keep choosing the 30-year option, you are restarting the interest train without making
much of a dent in the principal.
Shouldn’t we all choose the 15 year mortgage?
It certainly looks appealing to see the interest paid cut down by almost 60%, but one
mortgage calculation does not settle the debate. When someone chooses a 30-year
mortgage, they are exchanging payment flexibility with the cost of the interest. Depending
on your circumstances, the 30-year mortgage payment may be better for your budget.
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What can you afford?
First, consider the amount of the mortgage in the example: $260,000. That is the average
amount of national mortgage originations. $260,000 could easily help you get into a 1,000
square ft home in most of Miami Dade County, but in many areas of the country, that same
amount will be of little or no help getting you into a 900 square ft condo. Subsequently, a
15-year mortgage fitting into your budget will vary depending on where you live. To satisfy
your housing needs in certain areas, the 30-year may be the better option.
Do you need payment flexibility?
What about future income? Could you plan to go from a two-income household to one-
income in the future? The lower 30-year mortgage offers payment flexibility for those
future changes. You can pay your 30-year mortgage at the pace of a 15-year and then drop
down to the 30-year payment when changes in your income occurs.
How can you lower the amount of interest you pay without refinancing?
You can also choose to pay the same amount of a 15-year mortgage to your 30-year
mortgage. Typically, 30-year mortgages have a higher interest rate so it would cost a little
more than the normal 15-year mortgage, but again, you keep the flexibility of the 30-year
mortgage. If you paid the 15-year payment to the loan in our example, you pay off the loan
in just a little over 15 years. The total interest over the life of the loan would be $88,421.
That is still less than half the interest of the standard 30-year mortgage.
To achieve these results, you have to maintain a disciplined approach. One way to make
sure the payments occur regularly is setting up an automatic debit from your checking to
your mortgage. Just be sure to confirm those extra payments are being applied to
If you are still unsure if the 30-year or the 15-year is the best fit for your situation, get a
professional opinion from an unbiased financial planner. Some employers may even
provide you access to one for free through a workplace financial wellness program. In any
case, be sure to make your choice an educated one before signing up for the biggest loan
you’ll probably ever take.