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If you feel a little dazed and confused going through all the mortgage options out there, you’re in good company. Trying to make sense of it all is enough to make anyone’s head spin!
As you look at the different ways to finance your new home, the 15-year fixed-rate mortgage will probably pop up as an option. But what exactly is it?
A 15-year fixed-rate conventional mortgage is a mortgage loan charging an interest rate that remains the same throughout the 15-year term of the loan. These loans meet the guidelines and rules set by the Federal National Mortgage Association (FNMA). You know them better as Fannie Mae, one of the largest investors of conventional loans.
How does this mortgage option stack up against the competition? Let’s take a closer look at the 15-year fixed-rate mortgage, how it works and why it’s one of your best options when it comes to buying a house.
How Does a 15-Year Fixed-Rate Mortgage Work?
Fixed-rate conventional mortgages are sometimes called "vanilla wafer" mortgage loans. That’s because they are simple and easy to understand—there’s nothing complicated about them!
They offer a generic, structured process for financing a home: You get a mortgage for a set term, at a set interest rate, and lenders require a down payment—usually between 5–20%.
Before you shop for a house, get pre-approved.
Ideally, you’ll want to save up a down payment of at least 20% so you can avoid paying private mortgage insurance (PMI), which generally costs 0.5% of your loan each year. For a $200,000 loan, that’s an additional $83 to your mortgage payment each month, which adds up fast!
There are two basic components to every fixed-rate mortgage loan: the principal and the interest. The principal is the amount you borrow to purchase your home. The interest is the amount paid in order to compensate the lender for the risk of lending that money to you. In order to borrow money, you have to spend more money—go figure!
The only thing that varies with fixed-rate mortgages is the length of the mortgage term. You can stretch your monthly payments anywhere from 10 to 50 years, but the two most common term options are the 15-year and 30-year fixed-rate mortgage.
According to the Bureau of Labor Statistics, 14% of all home buyers used a 15-year fixed-rate mortgage to purchase a home between 2004 and 2014. Only 30-year fixed-rate mortgages (61%), which have lower monthly payments, are more popular.(1)
But just because the 30-year loans are the "popular" choice doesn’t mean they’re the best choice when it comes to buying a home. In fact, when you look deeper, you’ll find that the 30-year loan can wreak havoc on your financial future.
What Are the Advantages of Having a 15-year Fixed-Rate Mortgage?
Dave Ramsey will be the first to tell you that the absolute best way to buy a home is with cash. But if you decide to take out a mortgage, Dave only recommends getting a 15-year fixed-rate conventional mortgage with at least 10% down (20% or more down is better, as we mentioned above). And your monthly payment should be no more than 25% of your take-home pay.
What is it that makes 15-year fixed-rate mortgages the best option when it comes to financing your house? Here are some of the big advantages:
1. Your interest rate and monthly payment always stay the same.
With a 15-year fixed-rate mortgage loan, you repay the principal and interest each month through your monthly payment. Since this is a fixed-rate mortgage, the interest rate stays the same throughout the life of the loan. That means your monthly payment (not including taxes and insurance) will remain the same, too.
This will save you a ton of stress in the long run, because you’re protected from the risk of rising interest rates. So no matter what’s happening in the housing market, if your monthly payment is $1,500 on a 15-year fixed-rate mortgage, you’ll pay that each and every month for 15 years (unless you choose to pay more).
2. They have lower interest rates than most mortgage loans.
On average, 15-year fixed-rate mortgages come with lower rates than just about any other type of mortgage loan. That’s because with a 15-year loan, there’s less risk for the lender. The longer the term, the higher the risk of the loan not being repaid.
With a 15-year mortgage, you can usually get an interest rate between 0.25% to 1% lower than a 30-year mortgage. That might not seem like much, but the lower interest rate will save you thousands of dollars in the long run. More on that below.
By choosing a 15-year fixed rate conventional loan, you also won’t get hit with the fees that come with government-backed loans like a VA loan or an FHA loan.
3. They cost much less than other mortgages.
Many people ask the wrong question when they buy a home. They ask, "How much is the monthly payment?" They should be asking, "How much is the total cost of the loan?"
It’s true: 15-year fixed-rate mortgages have a higher monthly payment than 30-year loans. But when you crunch the numbers and look at the total cost of the loan, the difference between the 15-year and 30-year mortgages is staggering.
Let’s say you plan on borrowing $250,000 for a new home, and you’re trying to decide between a 15-year or 30-year mortgage.
The monthly payment (principal and interest) for a 15-year fixed-rate mortgage at 4.18% interest has a monthly payment of $1,872. If you went with a 30-year fixed-rate mortgage with a 4.76% interest rate, the monthly payment comes out to $1,306. You’d save $566 each month on monthly payments with the 30-year loan, but that’s just half the equation.
Going with the 30-year loan because of the lower monthly payment will end up costing you $130,000 more than if you went with a 15-year mortgage. That’s because of the total interest you will pay over the life of the loan. You could almost buy a whole house with the money you can save by choosing a 15-year loan!
4. You build home equity faster.
Here’s the thing you need to remember about home equity: Equity is the difference between what your home is worth and how much you owe on it. The more equity you have, the greater the portion of the home’s current value you actually own. One of the main ways you build equity is through paying down the principal of the loan.
In other words, you want more of your monthly payment to go toward the principal, not interest, so you can own more of your home. With the 15-year fixed-rate mortgage, you pay more toward the principal and build equity faster from your very first monthly payment.
But with the 30-year loan, it’s the complete opposite. Annually, you pay more toward interest (and less on the principal) for the first several years of the loan, which means you build equity at a much slower pace.
You can use our mortgage calculator to find out how much of your payment is going to principal and interest.
5. Your home gets paid off quicker.
You also might hear that 15-year fixed-rate mortgages are "fully amortizing" loans. That’s just a fancy term to describe the process of paying off debt with a planned, incremental repayment schedule. So if you make your scheduled monthly payments on your 15-year loan, your mortgage will be paid off by the end of the 15-year term.
A 30-year mortgage, on the other hand, will leave you in debt 15 years longer. That’s 15 extra years of your life in bondage to a bank. Here’s what that might cost you:
If you decide to invest your $1,872 monthly payment into good growth stock mutual funds for the next 15 years after your 15-year term is up, you could add $785,000 to $937,000 to your retirement fund. That sounds a lot better than 15 more years of mortgage payments!
Never get a mortgage term longer than 15 years. You’re basically throwing your money and your time away.
When Does Refinancing to a 15-Year Fixed-Rate Mortgage Make Sense?
Maybe you’re thinking this information would have been great to know five years ago, but you already bought a house with a 30-year mortgage. Or maybe you got stuck with an adjustable-rate mortgage (ARM) or interest-only loan, and you’re sick and tired of riding the roller coaster of rising and falling interest rates.
If that’s you, refinancing your mortgage is definitely an option to consider.
Mortgage refinancing revises the terms of your original mortgage to make a new mortgage. It could be a smart move if it lowers your interest rate or shortens your payment schedule.
Before you decide to refinance, there are some things you need to know.
When You Should Refinance
The ultimate goal of a refinance is to make a less than desirable mortgage better by locking in a 15-year fixed-rate mortgage with a new payment that’s no more than 25% of your take-home pay.
Refinancing makes the most sense if you fall into one of these categories:
- You have an adjustable-rate mortgage (ARM).
- You have an interest-only loan.
- Your mortgage has more than a 15-year term (such as 30 or 40 years).
- You have a high interest rate loan.
If you’re stuck in a 30-year mortgage with high interest rates, the gains you make by refinancing to a 15-year fixed-rate mortgage make it a no-brainer. It might mean a slightly higher monthly payment, but isn’t it worth it if you can have your house paid off years earlier and save thousands of dollars in the process? That’s a win-win!
But don’t forget to factor in the closing costs of a mortgage refinance, which can cost 3–6% of the loan amount.
When You Shouldn’t Refinance
But if you have a favorable interest rate on your 30-year mortgage, going through the expense of refinancing just isn’t worth it. Instead, use our mortgage payoff calculator to find out what your monthly payment would be on a 15-year term loan and commit to pay that extra amount each month.
The key here is to stay focused and keep making that extra payment. If you stick with it and simply pay on your 30-year mortgage like it’s a 15-year mortgage, you’ll get that balance down to zero faster than you think!
Need More Mortgage Help?
Whether you’re looking to buy a new house or refinance the home you already have, it’s important to have someone in your corner who can walk you through all your options. Picking the right mortgage is too big of a decision to make alone!
That’s why you should contact Churchill Mortgage. Their experienced loan specialists can show you the true cost—and savings—of each loan option and help you finance your home the smart way.