How does a 15-year mortgage loan work? What are the pros and cons of using a 15-year fixed home loan, when compared to the longer 30-year option?
These are some of the most common questions home buyers have about this particular mortgage product. The following guide will help you understand how a 15-year loan works, and if it’s the right choice for you.
What Is a 15-year Mortgage, Exactly?
Let’s start with a basic definition. This type of mortgage loan has a repayment window, or “term,” of 15 years. The debt is amortized (spread out over) a 15-year period, after which the loan is paid in full.
Of course, many homeowners who use these loans refinance or sell before the full term has expired. But when you take out a 15-year mortgage loan to buy a house, you are agreeing to a repayment term of that specific length.
How a 15-Year Home Loans Works
These loans generally have a fixed interest rate, which means that the mortgage rate you receive when you first take out the loan stays with you for the entire “life” or term.
There are some pros and cons to having a fixed interest rate for 15 years. It protects you from rising interest rates, but it might also cost you more in interest when compared to an adjustable-rate mortgage or ARM. (But there are pros and cons to using an ARM loan, as well.)
Usually, a 15-year home loan is amortized in such a way that the borrower pays mostly interest during the first few years of the term. As time goes on, however, this ratio gradually changes and the borrower pays more toward the principal. Near the end of the repayment term, most of the monthly payment gets applied toward the principal. This is usually how it works — your lender can show you the particulars of your loan when you apply for it.
Now that you know how a 15-year mortgage loan works, let’s look at the pros and cons.
Understanding the Pros and Cons
The 30-year fixed-rate mortgage is by far the most popular financing product in use today. It accounts for the vast majority of home loans that are originated in the United States.
But there are situations where a 15-year mortgage loan might be a better option, financially. The key to choosing the right loan is to understand the pros and cons associated with it.
One of the primary advantages of using a 15-year mortgage (versus a 30-year product) is that you pay less interest over the long-term. That’s because you are keeping the loan for a shorter period of time, and making fewer payments.
Remember that interest is applied to every one of your monthly mortgage payments when using either a 15- or 30-year loan. So the longer you keep it — and the more payments you make — the more you’ll end up paying in total interest.
The primary disadvantage to using the 15-year option is that you could end up with a higher monthly mortgage payment, when compared to a 30-year fixed home loan.
A Real-World Comparison Between These Loans
When this article was published, in August 2017, the average rate for a 30-year fixed home loan was 3.93%. The average rate for a 15-year mortgage was 3.18%. This is based on the weekly survey conducted by Freddie Mac, which you can find online. It’s common for the 15-year mortgage to have a lower interest rate than its longer-term counterpart.
Using a mortgage calculator, let’s look at how this rate difference would affect the borrowers’ long-term costs. Let’s assume two borrowers are taking out home loans in the amount of $200,000.
- Borrower ‘A’ is using a 30-year fixed mortgage with an interest rate of 3.93% (the average mentioned earlier).
- Borrower ‘B’ is using a 15-year loan with an interest rate of 3.18%.
Let’s further assume that both of these homeowners actually stay in their homes and fulfill the entire repayment term. Here’s how their monthly payments and long-term costs would vary.
- Borrower ‘A’ (who used a 30-year fixed mortgage) would have a monthly payment of $947, and would end up paying $140,839 in total interest over the 30-year period. The total cost of the loan over 30 years, including principal and interest, would come to $340,839.
- Borrower ‘B’ (who used a 15-year mortgage loan) would have a monthly payment of $1,399, and would end up paying $51,738 in interest over the 15-year repayment term. The total cost of the loan in this scenario would come to $251,738 after 15 years.
This real-world scenario highlights the pros and cons of the 15-year fixed mortgage loan. Borrower ‘B’ had a higher monthly mortgage payment due to the shorter term. That’s the downside. But she also paid a lot less in total interest over the long-term, and that’s the upside.
Borrower ‘A’ (who used a 30-year mortgage loan) ended up paying nearly three times as much in total interest over the life of the loan. That’s because the 30-year option came with a higher interest rate from day one, and the homeowner paid that higher rate over a longer period of time.
Conclusion: Which One Is Right for You?
This article gives you a basic idea of how a 15-year fixed home loan works, and when it might make sense to use one. The key here is to consider the pros and cons in light of your specific financing goals.
- If your primary goal is to reduce the size of your monthly payments, then you’re probably better off with a 30-year home loan.
- If you can afford a larger monthly payment, and you want to reduce the amount of interest paid over the long term, then the 15-year mortgage loan might be a better option for you.
When applying, ask your lender to explain how your payments will work out over time – including the total amount of interest you’ll pay. Better yet, have them present you with multiple options, so you can see which one works best for you.
Disclaimer: This article offers a basic overview of how the 15-year mortgage loan works, and how it’s different from the more popular 30-year option. Every lending scenario is different, because every borrower is different. So your situation might differ from the examples presented above.
Brandon Cornett is a veteran real estate market analyst, reporter, and creator of the Home Buying Institute. He has been covering the U.S. real estate market for more than 15 years. About the author