When I got into the mortgage industry in 1988, interest rates were in double-digit territory. Today, 30-year loans make more sense than ever with mortgage interest rates continuing to set new all-time lows. Just last week, a person with excellent credit could get a 30-year loan for rates as low as 3.375% and 15-year loans for an incredible 2.75%.
So is the 30-year mortgage a better choice? One of the biggest advantages is its flexibility. Note holders of 30-year loans can always make the extra payments required to pay them off in 15 years, should they choose to do so.
Of course, the trade-off for having additional flexibility is higher interest payments.
Assuming a $200,000 loan, the impacts of those higher interest payments over time at today’s rates can be seen in the following chart:
As you can the 30-year mortgage are going to pay more interest, whether or not you make the extra payments required to retire the loan in roughly 15 years. Then again, how much more depends on how picky you are about getting the loan paid off in exactly 15 years.
In the example, a 30-year $200,000 mortgage at 3.375% results in a monthly payment of $884. Over 30 years, the homeowner would end up paying $118,309 in interest of the life of the loan — $74,000 more than a homeowner with a 15-year loan at 2.750%.
However, those who are serious about minimizing their interest costs by paying off that same 30-year loan in exactly 15 years could do so by increasing the monthly payment to $1,424 — $540 more than the minimum payment and if you need to have the extra funds of the $540 for an emergency then go back to the 30 year payment.
Over the life of the loan, that strategy would result in interest expenditures of only $10,491 more than the 15-year mortgage. Spread out over 15 years, it’s a premium of $58 per month. Not bad at all for those looking for the added peace of mind.
Alternatively, faithfully making monthly payments over the life of the loan equal to that required by a 15-year mortgage at 2.75% ($1,357) would result in slightly higher additional interest costs of $14,330. That’s a premium of $74 per month over the life of the loan, which would be a bit longer — 15 years, 11 months.
So there you have it. Hopefully, this little example provides you with a bit more insight into just how much extra it currently costs to take on a 30-year loan over its 15-year cousin.
As you can see, no matter how you slice it, people who prefer the numerous advantages of a 30-year loan over a 15-year mortgage are always going to pay more interest. But for those who are looking for the extra flexibility of a 30-year loan as a hedge against a sudden loss of income, the added premium is a relative bargain.