While the pain of the housing sector decline still resonates with many Americans, the real estate market appears to be on a sustainable path to recovery. Homeowners are finally seeing increases in equity, foreclosure rates have been slowing down and consumer confidence is growing. While undoubtedly the culmination of several key factors, the recent recovery can partially be attributed to restructuring lending practices. In order to prevent prospective buyers from entering into toxic loan scenarios, the government established the Consumer Financial Protection Bureau (CFPB) in 2010.
In an effort to disclose the risks and costs associated with a mortgage, the CFPB has taken several steps to make the process more translucent. Accordingly, disclosure forms were distributed to help consumers understand what they were getting into with the acquisition of a loan. However, a majority of buyers are still unsure which type of mortgage is right for their particular situation. The differences between a 15-year fixed-rate mortgage and a 30-year fixed-rate mortgage are substantial enough to warrant further understanding.
Despite the rise in popularity of the 15-year mortgage, the underwriting may not be attractive to everyone. Buyers intent on receiving a mortgage are advised to retain as much information as possible pertaining to each respective loan. Perhaps even more importantly, buyers need to understand the different terms that accompany each one. While the amount being borrowed is relatively easy to comprehend, the cost of the loan and the interest rate is more ambiguous.
Borrowers must understand how payments, which consist of principal repayment and interest, will be structured under the different types of mortgages. They need to consider how much they will be paying for the loan, not only now but also in the future. They should also consider their budget, age and other factors before deciding on a mortgage.
We advise asking yourself the following questions before you decide between a 15-year and a 30-year mortgage:
Can you afford to pay off the mortgage in 15 years?
While a 15-year mortgage offers a lower rate relative to a 30-year mortgage, monthly payments are considerably higher. The nature of the loan forces the borrower to pay down the principal in a shorter period of time, thereby increasing monthly payments. Over the course of a loan, 15-year mortgages result in less interest, but not everyone can afford the increased monthly payment that accompanies it.
According to Guy Cecala, publisher of Inside Mortgage Finance, “if you can afford the higher payments associated with the shorter-term 15-year mortgage, there is no reason not to take one.”
The higher monthly payment that coincides with a 15-year fixed-rate mortgage can easily be a burden to those who were not prepared for the additional financial stress. Money allotted to the mortgage is money that can’t be used for something else. Those who feel their financial situation can’t support the added payment are advised to consider a 30-year mortgage. Similarly, if the higher payments of a 15-year mortgage mean borrowers have less money to invest elsewhere and diversify their portfolios, they may be better off with a 30-year mortgage.
Are you buying your first home?
First-time homebuyers often share similar financial situations. They are less likely to be financially stable and have job security. Therefore, monthly payments are a large consideration to anyone purchasing their first home. Accordingly, this population usually benefits from a 30-year mortgage. The lower monthly payments are more suited to their current living situation. A longer-term mortgage can make an expensive home more affordable.
Are you looking to refinance?
Even those who already have a mortgage should take the time to familiarize themselves with the options made available to them. Knowing the differences between mortgages can save a lot of money in the event of a refinance. According to Cecala, now is a good time to refinance for those who have high monthly payments on a 30-year loan. You might be able to refinance into a 15-year mortgage and make similar monthly payments while shortening your mortgage term. The difference in rates between a 30-year and a 15-year mortgage will surprise many buyers.
According to Cecala, “the difference between the 30-year fixed rate and the 15-year fixed rate has been about 25 basis points,” or approximately 0.25 percent.
Are you retiring soon?
The possibility of retirement may play a huge role in deciding which mortgage term you receive. Cecala acknowledged that the majority of buyers who take out a 15-year loan are over the age of 40. This is likely because of an impending retirement. These borrowers want to pay off their loan before they retire so their post-career life is not clouded by outstanding debts.
However, older borrowers then need to weigh the importance of saving for retirement and making payments on their home. According to the CFPB, 30 percent of homeowners ages 70 and older have outstanding mortgages.
Do you have a strict savings plan?
Disciplined savers may benefit fro the acquisition of a 15-year mortgage, as opposed to a 30- year loan. In fact, some may actually benefit from carrying over their mortgage into retirement. According to a May story published by Time magazine: “If you expect to earn more after tax on your investments than you pay after tax on your mortgage, keep the mortgage.”
Unfortunately, too many people lack the discipline of saving for a long period of time. The money they should be saving for mortgage payment is often allocated to other areas of their life.