Here's Why a 30-Year Mortgage Is a Smart Financial Choice

By Dan Rafter on 10 December 2015 0 comments

The pros of a 15 versus 30-year mortgage are simple. If you take out a 15-year fixed-rate mortgage loan, you’ll pay far less interest over the life of your mortgage. But, if you take out a 30-year fixed-rate mortgage loan, you’ll have a smaller payment each month.

Because of this, a 15-year loan would seem to be the smarter financial choice, as long as you can afford the higher monthly payment that comes with it. You’ll be savings tens of thousands of dollars in interest by going this route, depending upon how long you hold onto this loan.

But there are times when a 30-year loan is the better financial choice, even if the larger monthly payment of a 15-year loan fits within your budget. It all depends upon what you do with the dollars that you save each month thanks to that lower payment.

"Choosing a 30-year fixed-rate loan over a 15-year loan gives borrowers a safety net in case they suffer an economic setback," said Greg Cook, a mortgage consultant with Platinum Home Mortgage in Temecula, California. "While things are good, they can always make the 15-year payment and revert to the 30 when things are tight."

You Gain Flexibility With a 30-Year Loan

A 30-year mortgage loan provides homeowners with the most flexibility. While this loan requires a lower monthly payment than a 15-year version, homeowners can pay extra each month toward principal if they have extra money available in a given month. This will allow them to pay down their loan at a quicker pace. And if they are having a tougher month, they can pay the lower required payment.

"When borrowers are not certain of their job stability, then having a lower minimum monthly payment can be a huge stress-reducer," said Casey Fleming, author of The Loan Guide: How to Get the Best Possible Mortgage.

The 30-year mortgage, because of its lower payment, also makes sense for borrowers who rely heavily on commissions or bonuses as part of their income. If they have a month in which they earn a big bonus, they can pay more on their home loan. If they have a month without a big bonus or commission check, they can instead pay the required lower payment.

But You Spend a Lot More Money Over Time

Going by the raw numbers alone, a 30-year loan rarely makes financial sense if you can afford the payment that comes with a 15-year mortgage.

Say you take out a $300,000 30-year fixed-rate mortgage with an interest rate of 4%. If you took the full 30 years to pay off this loan, you'd end up paying a total of $515,608.52 in principal and interest. (This figure doesn't include what you would pay for homeowners insurance and property taxes.) If you took out that same $300,000 as a 15-year fixed-rate loan with an interest rate of 4%, you'd pay a total in principal and interest of $399,431.48 if you took the full 15 years to pay off your loan.

You'd save $116,177 by going with the 15-year loan. That's a significant amount of money.

But mortgage professionals say that this doesn’t automatically make the shorter-term mortgage the right choice. Robert Johnson, president and chief executive officer of The American College of Financial Services in Bryn Mawr, Pennsylvania, said that it makes sense for homeowners to go with a longer loan if they use the money that they'll save each month wisely, such as for boosting their retirement savings.

In the above example, homeowners would pay about $786 less each month for a 30-year mortgage. If homeowners use these extra dollars to increase their retirement savings, taking out the longer-term loan might be a good financial decision, Johnson said.

"Too often, people stretch their limits and make their mortgage payments but not much else," Johnson said. "Financial planners know that saving for financial goals is not linear. People need to plan for multiple goals at one time — making mortgage payments, saving for kids' college expenses, and saving for retirement."

Those homeowners who are disciplined enough to invest their monthly savings are often good candidates for a longer-term mortgage, too.

Invest the Difference, Instead

Robert Greene, regional vice president of Austin, Texas-based The Solomon Group, said that homeowners who have about an extra $425 in savings each month because they are paying off a 30-year mortgage could invest that money in an interest-bearing account. If that account on average generated 8% interest, in 15 years those homeowners would have accumulated about $147,239 in savings. If homeowners continued to invest that same amount of money for 30 years at an average rate of return of 8%, they would have $634,147 in savings.

"Would you rather grow equity in a home that is not liquid or equity outside the home that is?" Greene asks.

This assumes, however, that you will invest or save that extra money each month — and that it will earn a higher rate of return than you pay in interest on the mortgage. If you’re more apt to spend those extra dollars and you can afford the payment that comes with a shorter-term loan, it might make more sense to go with that 15-year loan and reduce the amount of interest you’ll pay.

Are you taking advantage of the flexibility a 30-year loan offers?

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Guest's picture
Yetisaurus

I agree that the 30 year loan gives you flexibility, and it can be handy to have a lower loan payment obligation if you're applying for another loan, e.g., if you're looking to take out a new mortgage to buy an investment property. If you stretch yourself too far on your mortgage, the bank may not let you borrow enough to get the investment property you want.

But one thing the post didn't mention is that shorter term loans usually have lower interest rates, too. So the savings comes not only from paying off the loan early, but from the difference in interest rates. I usually run a couple of amortization schedules before deciding, but if it looks like I can save a good amount of interest in the first few years by going for the shorter term loan, I will usually take the shorter loan with the thought that I can refi in several years if I need to reduce my monthly payments at that point to get more flexibility.