An Endorsement of the Underrated 15-Year Fixed Rate Mortgage
A fixed rate mortgage will be one of the endless supply of options you will be you will be presented with when buying a home. Well, maybe using the word endless was a bit hyperbolic, but you will have a lot of options. And doing the necessary research and performing your due diligence to better understand those options will be crucial to you finding the best deal.
Mortgages are not exactly a one-size-fits-all solution. There are so many types of mortgages available — fixed rate, adjustable or variable rate, balloon, interest only, compound — and the deeper you dig, the more it seems like the only common bond they share is that they’re used to buy a home. So if all of these mortgages can potentially get you the home you’re looking for, how do you know which route to take?
We encourage you to do your research and see what works for you, but we here at Banks.com are almost going to always recommend that the underrated (and often times undersold) 15-year fixed rate mortgage at least be considered. Allow us to plead our case..in a sea of complex mortgage products, something as simple as a 15-year fixed rate mortgage can save you a lot of money over the long-term and still help you get the house of your and your family’s dreams.
What Is a Fixed Rate Mortgage?
A fixed rate mortgage has an interest rate that stays the same throughout the life of the loan. The duration of a fixed rate mortgage varies but they are typically between 15 and 30 years in length. Whenever you make payments on a fixed rate mortgage some money will go to interest and the remainder will go toward the principal balance. In the beginning, a larger portion of your payments will go to paying the interest. Over time your principal balance will decrease, and that will free up more of the monthly payment amounts to go toward the remaining balance and not the interest.
What are the benefits of a fixed rate mortgage?
- Predictable Monthly Payments: They are the same amount throughout the life of the loan which makes it easy to plan for in the future.
- Home Equity Availability: Each month more and more of the principal loan amount is paid off which increases your home’s equity. This is in contrast to something like an interest-only mortgage where equity is not being freed up with each payment.
- Guaranteed Interest Rate: You are locked into a specific interest rate for the life of the mortgage. If the market takes a drastic turn and interest rates shoot up, your fixed rate mortgage would stay exactly the same.
- Pay It Off Early: Fixed rate mortgages are least likely to have any fees for making early payments. This means that you can make extra payments to pay your mortgage off sooner, without the risk of incurring prepayment penalties.
Are there downsides to a fixed rate mortgage?
Of course there are. Any major financial decision you face in life will come with its own set of pros and cons. One powerful tip is to go with the option where the supposed negatives simply do not apply to your specific scenario.
- Higher Interest Rate: The interest rate on a fixed rate mortgage will likely be higher than that of an adjustable-rate mortgage or an interest-only mortgage. If interest rates fall in the future, you may be stuck at the higher rate assuming a refinance is not on the table.
- Slower Principal Payments: Because fixed rate mortgage payments go mostly towards interest during the first few years, the principal balance is chipped away at much faster early on with an adjustable-rate mortgage.
- Difficult Approval Process: It is harder to get approved for a fixed rate mortgage than most of the other available options. The bank is taking a huge risk whenever someone promises to pay them back over the course of 15-30 years. They want to be as safe as possible when selecting viable candidates.
The Wonderful 15-Year Fixed Rate Mortgage
For those who are considering a fixed rate mortgage, a 15-year repayment time frame often aligns nicely with the future goals of many American homebuyers. Before we go over the advantages, let’s go over the top two reasons why a 15-year fixed rate mortgage may not be for you.
- You plan to sell your home within 5-7 years – Since a good chunk of payments in the early years go towards interest and less towards principal, you may be better off with an interest-only or adjustable-rate mortgage.
- You need a low monthly payment – Sure, the interest on a 15-year term is going to be lower, but the monthly payment will be higher. If you are concerned about fluctuations in your income and want to ensure the lowest possible monthly payment, a fixed rate mortgage with longer repayment terms may be for you.
Now, on to the good stuff! Here are some of the top factors to consider when deciding how long (or short) of a mortgage you want to get yourself into.
- Lower Interest Rates: A 15-year term offers much lower interest rates than that of a mortgage with longer payment terms. The shorter your payment terms, the less of a gamble the bank has to take with you. If you’re not much of a risk then you will be offered a lower rate.
- Lower Interest Payments: Less overall payments, at a lower interest rate, means less in interest that you will pay over time.
- Faster Equity Building: You will build equity in your home much faster with a 15-year mortgage.
- Reduced Market Risk: The longer you hold a mortgage for, the more at risk you are for sudden or drastic market fluctuations. Paying your home off in 15 years as opposed to 30 means you’re more likely to avoid an event like the 2008 mortgage crash that had many people owing more on their homes than they were worth.
- Easy Refinancing : Building equity faster with a 15-year mortgage makes it easier for you to refinance in the future should you decide to take advantage of potentially lower interest rates.
Interest & Payments: 15-Year vs. 30-year Terms
15-year fixed rate mortgage has the lowest rates available when compared to 20, 25, and 30-year fixed rate loans. This difference in interest rates can be as small as a fraction of a percentage point. On the surface a difference in interest rates that is less than one percentage point can seem insignificant, especially to those who are first-time homebuyers, but it adds up quickly.
You may think to yourself that a 30-year loan has lower monthly payments and, at a fraction of a percent difference, the actual rates are too close to even matter. Well, if your sole concern is a lower monthly payment then that’s one thing. If you’re brushing it off as not that big of a difference, then that’s a completely different ballgame.
Consider this: You want to buy a home for $200,000 so you shop around for mortgage rates. The best quote comes back at 4.25% for a 30-year mortgage and 3.65% for a 15-year mortgage.
- The monthly payments would be: 15 Years – $1,445| 30 Years – $984
That lower monthly payment looks much more attractive, doesn’t it? Well, let’s break this down a bit more.
- Total amount paid over the course of the loan:15 Years – $260,018 | 30 Years – $354,197
In this instance, a 30-year loan has you paying nearly $100,000 more over time. Not only does the 15-year loan save you more money in the long run, it also frees up your monthly mortgage payment twice as early. An extra $1,000-$1,500 is now suddenly available 15 years quicker. What would you do with the extra money each month? What would you do with the hypothetical $100,000 that was saved in the long run?
If you want to pay as little as possible over time, a 15-year term is the best choice for a fixed rate mortgage. The common complaints, like the monthly payment being higher, are easily overlooked when you focus on long-term goals.
However, maybe that higher monthly payment is too intimidating? Or maybe you can afford it now, but worry about where you see yourself 5 years from now? Fixed rate mortgages usually don’t have prepayment penalties. You can always get a loan at longer terms and just pay extra each month. You will still have the higher interest rate, but making extra payments is rarely penalized and is good practice for quickly paying down debt.