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When the Hobfoll family moved into their current home in Des Moines, Iowa, they took out a 30-year mortgage, even though they could afford a 15-year loan.
30-year loans generally have a higher mortgage rate than a 15-year loan, but lower monthly payments. Even if they could swing it, the Hobfolls had a hard time justifying the extra $500 to $600 a month the shorter-term mortgage would have cost them. Jordan Hobfoll recently switched to running his own business full-time, which he knew would cut into the family’s income as he built the business.
“The flexibility of the 30-year contract [loan] has become more appealing,” Hobfoll said. “If the worst comes to the worst, you are not committed to the higher payment.”
Most borrowers cannot plan for lost income. That’s why some experts recommend 30-year mortgages for the majority of homeowners, although a 15-year mortgage may fit your budget. You can still repay the loan early, but the smaller monthly commitment of a 30-year loan provides the flexibility to pursue other financial goals, such as investing for retirement, coping with financial hardship, or building a fund. emergency.
Here’s why a 30-year loan might be better than a 15-year loan
With a smaller monthly payment, you’ll have greater flexibility to pursue a wider range of financial goals and you’ll be better able to weather economic uncertainty.
Two of the main advantages of shorter mortgage repayment terms, like 15 years, are that they end up being cheaper in the long run and you can pay off the mortgage faster. However, you can still pay off a 30-year loan as quickly as you want. According to the law, there is cannot be prepayment penalties after three years.
Since there is no additional cost to pay off a 30-year mortgage in half the time, “it seems like a wise course of action as a consumer to go for a 30-year mortgage and then to make a conscious decision on your own to pay off in 15 years,” says Mitria Wilson-Spotserdirector of housing policy at the Consumer Federation of America, a nonprofit consumer advocacy organization.
Here are two reasons why experts say a 30-year loan might be a better option than a 15-year loan.
1. Ability to manage economic uncertainty
The monthly payment for a 15-year loan is usually about 50% higher than for a 30-year loan of the same amount, even taking into account the lower interest rate.
Shorter loans allow you to build up equity in your home faster, but all that equity may not help you much when times get tough. If you lose your job or your income is reduced, turning the value of your home into cash with a home equity loan, home equity line of credit (HELOC) or cash refinance becomes more out of reach. Without proof of stable income, it becomes more difficult to qualify for these stock options.
“We keep calling these major financial crises in America unprecedented events, but they keep happening,” says Kyle Seagraves, a Certified Mortgage Advisor with homebuyer education site and YouTube channel “Win The House You Love”. The finances of many households have been strained during the last financial crash and the COVID pandemic. In those situations, Seagraves says he would much rather commit to a 30-year loan with a lower payment than a 15-year loan.
2. Flexibility to pursue other financial goals
While it can be great to increase the equity in your home, it’s worth thinking about what you could do with the money you’ll free up with longer-term financing.
The Hobfolls took advantage of the extra money in their monthly budget and built up their short-term emergency savings. “Part of flexibility is not just monthly budget flexibility; it’s how much money you have in the bank,” says Hobfoll.
Andrew Lokenauth recently purchased his first home in Tampa, Florida, and opted for a 30-year loan, even though he could have handled a 15-year repayment term. Lokenauth says he did this so he could invest the difference. For him, it was all a question of opportunity cost: “I think in the long term. In 30 years, I would rather accumulate this money in a large investment to retire than save a few thousand dollars.
The S&P 500 Index has averaged a rate of return of between 10% and 11% since 1926, which is significantly higher than the interest rate reduction you would get on a 15-year loan. Lokenauth estimates he saves nearly $1,000 a month with a 30-year mortgage. “Instead of putting in that extra $1,000 to save 1%, I’d rather put in the $1,000 to save 11%,” he says. “I wanted my money to grow in the long term.”
Invest monthly savings from a 30-year loan
If you have a $250,000 home loan, here’s what your payment might look like:
|Interest rate||Monthly payment||Total interest paid on the mortgage|
|30 year loan||3.5%||$1,122||$154,309|
|15 year loan||2.82%||$1,704||$56,920|
Even though you would pay $97,389 more in interest with a 30-year loan, you can still win by investing early. If you invested the difference of $582 each month in an S&P 500 index fund and had a conservative average return of 7%, here’s what your investment would look like compared to paying off your mortgage.
|Amount invested each month until year 15||Balance of investments at year 15||Amount invested each month: 16-30 years||Balance of investments at year 30|
|30 year loan||$582||$184,472||$582||$710,023|
|15 year loan||$0||$0||$1,704*||$540,104|
In this situation, the 30-year borrower invested early with a lower contribution and the 15-year borrower waited until the loan was repaid to invest. Even with the higher monthly contribution of $1,704, the rate of return (ROI) is higher by starting to invest earlier, even with the lower contribution amount. Under this scenario, the borrower over 30 years would have $169,919 more after 30 years. Taking into account the additional interest paid by the borrower over 30 years ($97,389), they are still up by $72,530 in total.
Do what makes the most sense for your particular situation
The loan that is best for you depends on your goals and your personal situation.
If paying off your mortgage as quickly as possible is your top priority, a 15-year loan is a more cost-effective way to achieve that goal. In the loan example above, the 30-year-old paid $97,389 more in total interest. Taking out a 15-year loan can be a good way to motivate you to stick with the goal of paying off your mortgage as quickly as possible. In this situation, the safest way to proceed is to have a fully funded emergency fund to weather any financial storms. You may also want to balance paying off your mortgage with funding tax-advantaged retirement accounts.
It’s also important to take an honest look at what you’ll do with the extra money if you opt for the lower monthly payment on a 30-year loan. If you don’t invest or save what you would have spent on a larger 15-year mortgage payment, the potential benefits of a 30-year loan are diminished.