15-Year vs. 30-Year Mortgage: What's the Difference? Much more than the amount of monthly payments
In a 30-year mortgage, of course, that balance shrinks much more slowly—effectively, the homebuyer is borrowing the same amount of money for more than twice as long. In fact, it’s more than twice as long rather than just twice as long because, for a 30-year mortgage, the principal balance does not decline as fast as it does for a 15-year loan.
The higher the interest rate, the greater the gap between the two mortgages. When the interest rate is 4%, for example, the borrower actually pays almost 2.2 times more interest to borrow the same amount of principal over 30 years compared with a 15-year loan.
Consumers pay less on a 15-year mortgage—anywhere from a quarter of a percent to a full percent (or point) less, and over the decades that can really add up.
Imagine, then, a $300,000 loan, available at 4% for 30 years or at 3.25% for 15 years. The combined effect of the faster amortization and the lower interest rate means that borrowing the money for just 15 years would cost $79,441, compared to $215,609 over 30 years, or nearly two-thirds less.
Of course, there's a catch. The price for saving so much money over the long run is a much higher monthly outlay—the payment on the hypothetical 15-year loan is $2,108, $676 (or about 38%) more than the monthly payment for the 30-year loan ($1,432).
If an investor can afford the higher payment, it is in their interest to go with the shorter loan, especially if they are approaching retirement when they will be dependent on a fixed income.
There are some instances where a borrower may have an incentive to invest the extra money spent each month on a 15-year mortgage elsewhere, such as in a 529 account for college tuition or in a tax-deferred 401(k) plan, especially if the employer matches the borrower’s contributions. And with mortgage rates so low, a savvy and disciplined investor could opt for the 30-year loan and place the difference between the 15-year and 30-year payments in higher-yielding securities.
Using the previous example, if a 15-year loan monthly payment was $2,108, and the 30-year loan monthly payment was $1,432, a borrower could invest that $676 difference elsewhere. The back-of-the-envelope calculation is how much (or whether) the return on the outside investment, less the capital gains tax owed, exceeds the interest rate on the mortgage after accounting for the mortgage interest deduction. For someone in the 24% tax bracket, the deduction might reduce the effective mortgage interest rate from, for example, 4% to 3%.
A Best-of-Both-Worlds Option
Most borrowers evidently also lack—or at least think they lack—the wherewithal to make the higher payments required by a 15-year mortgage. But there is a simple solution to capture much of the savings of the shorter mortgage: Simply make the larger payments of a 15-year schedule on your 30-year mortgage, assuming the mortgage has no prepayment penalty.
A borrower is entitled to direct the extra payments to the principal, and if the payments are consistent, the mortgage will be paid off in 15 years. If times get tight, the borrower can always fall back to the normal, lower payments of the 30-year schedule.
The Bottom Line
The decision between a 30-year or 15-year mortgage is one that will impact your finances for decades to come, so be sure to crunch the numbers before deciding which is best. If your aim is to pay off the mortgage sooner and you can afford higher monthly payments, a 15-year loan might be a better choice. The lower monthly payment of a 30-year loan, on the other hand, may allow you to buy more house or free up funds for other financial goals.