Should You Consider a 15-Year Mortgage?

As interest rates inch upward, home-buyers looking to save on their loan may be considering 15-year mortgages instead of the traditional 30-year mortgage. Or those refinancing their mortgage may look into shortening the term with a 15-year mortgage. In fact, Freddie Mac data shows that 31 percent of homeowners who refinanced during the second quarter of 2013 shortened their loan term (a three percent increase from the previous quarter).

A 15-year mortgage is best suited for those who are financially secure, says Rick Scott, an assistant professor of finance at Saint Leo University in Florida. “Most people that do a 15-year mortgage have a lot of savings or high income so they’re not worried about making that payment,” he explains.

Here’s a look at some pros and cons to consider before choosing a 15-year mortgage, as well as some alternatives.

Pros

Those with a 15-year mortgage pay less interest over the life of the loan and typically get a lower interest rate. Between June 2012 and June 2013, the average rate on a 15-year mortgage was below three percent, according to Freddie Mac. As of August, that rate had inched up to almost 3.5 percent compared to almost 4.5 percent for a 30-year mortgage. There’s also the psychological benefit of paying your home off sooner.

“In 15 years, you own the house, as long as you make the payments,” Scott points out.

Cons

The big downside of a 15-year mortgage is, of course, that it locks you into a higher monthly payment. Many people like to buy as much house as they can afford, so they opt for a 30-year mortgage and stretch out the loan repayment.

Before choosing a 15-year mortgage, Mauricio Rodriguez, chair of the finance department and a professor at the Neeley School of Business at Texas Christian University, urges consumers to “carefully look at their budget and liquidity needs and also account for a little cushion for unforeseen expenses like a car breaks down or a child gets sick.”

Potential Alternatives

To get some of the benefits of a 15-year mortgage without the potential liquidity issues associated with a higher monthly payment, Rodriguez suggests getting a 30-year mortgage and paying it as if it had a 15-year term. Most residential mortgages, including VA loans, do not have a prepayment penalty, so you could pay off the loan sooner and pay less interest over the life of the loan but still have the flexibility to scale back your payments in case of a job loss or cash flow problems.

The downsides to this approach are that it requires more self-discipline to pay extra each month and does not get you the rates associated with a true 15-year mortgage.

Photo courtesy Dougtone