Because interest rates have declined in recent years, many homeowners have refinanced their 30-year mortgages to mortgages with 15-year terms.

  • Why?

    With a 15-year mortgage, interest rates are generally lower. The "spread" (difference) between the interest rate on a 15-year loan and its longer-term cousin may not be great, but over 30 years even a small difference in rates can add up. For example, let's say you take out a 30-year mortgage for $150,000 with an annual interest rate of 5%. To cover principal and interest your monthly payments will be $805.23. Over the term of the loan, assuming you make all payments on time and don't make any extra payments, you'll pay total interest of $139,883. A 15-year mortgage for that same amount with a slightly lower interest rate of 4.5% will require monthly payments of $1,147.49 (again, principal and interest). Over the life of the mortgage, you'll pay $56,548 in interest—a savings of $83,335.

    In addition, with a 15-year mortgage you build equity faster and own the house sooner. You don't have to discipline yourself to make extra principal payments because your mortgage contract requires higher monthly payments. In essence, the higher payments are like required deposits to a savings account.
  • Why doesn't every homeowner sign a 15-year mortgage?

    For one thing, with a 15-year mortgage you're locked into higher payments over the term of the mortgage. That means less flexibility in your budget. With a 30-year mortgage, you can make extra payments as money becomes available. A shorter-term mortgage also impacts your debt-to-income (DTI) ratio, a rule of thumb that's used by bank loan officers. To find your DTI ratio, take all of your debt payments (mortgage, credit cards, car loans) and divide the total by your gross monthly income. If the result is greater than 35%, you may not be able to afford (comfortably, at least) the higher payments required by a 15-year mortgage.

    People often deceive themselves about their level of financial discipline. One study by the Federal Deposit Insurance Corporation (FDIC) found that over 97% of homebuyers do not consistently pay extra on their mortgages. If it's unlikely that you'll actually make additional principal payments on your 30-year mortgage, you might consider the "forced savings" of a 15-year loan. But be sure you are making regular contributions to retirement accounts and have wiggle room in your budget to cover emergencies.

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