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Financing a home purchase? Read on to see why one specific type of mortgage might save you money.
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Most people cannot afford to pay for a home in cash. If you’re in that boat, you’ll need to finance your home purchase with a mortgage. But you have choices in that regard.
Mortgages come with terms of differing lengths. And while 30-year mortgages tend to be the most popular among home buyers, there’s also the option to take out a 15-year loan.
Financial guru Dave Ramsey says, “The only type of mortgage you should consider is a 15-year, fixed-rate conventional mortgage.” He also says, “Going with a 15-year instead of a 30-year will save you tens of thousands in interest.”
He’s right about that last part. But whether you can actually swing a 15-year mortgage is a different story.
The savings could be huge
Taking out a 15-year mortgage rather than a 30-year one could save you a lot of money on interest for two reasons. First, you’re paying off that loan in a shorter period of time, so you’re not paying as much interest by virtue of that alone. You might also snag a lower mortgage rate to begin with by signing a 15-year loan instead of a 30-year loan.
In fact, let’s say you’re buying a $400,000 home and are putting down 20%, or $80,000, at closing. Let’s also say you sign a 30-year mortgage at 6.39%, which is the average rate for that loan product as of late April 2023, per Freddie Mac. In that case, you’ll end up spending about $400,000 on interest in the course of paying off your home. (Yes, you read that correctly.)
Meanwhile, the average rate today on a 15-year loan is 5.76%. If you borrow the same $320,000 at that rate over 15 years instead, you’ll end up spending more like $159,000 on interest all in. That’s a savings of around $241,000.
Now, think about the things you can do with $241,000. You could put your kids through college, or take a really nice vacation every year for well over a decade. So it’s easy to see why a 15-year mortgage might be a tempting prospect.
Can you afford a 15-year mortgage?
Clearly, there are savings to be reaped on interest when you opt for a 15-year mortgage over one that’ll take you double the time to pay off. But before you rush to sign a 15-year mortgage, consider whether the higher payments that come with it will work for your budget.
In the above example, your monthly payment of principal and interest for a 30-year loan comes to $1,998. For a 15-year loan, it’s $2,659. That’s a $661 difference per month, and you may not be able to swing that higher amount.
That’s why Ramsey’s advice, although spot-on, won’t apply to everyone. If you can handle the higher monthly payments of a 15-year loan, then you might as well save yourself money on interest — especially at a time like this, when mortgage rates are just plain up across the board. But if those higher payments are a stretch for you, then you may be better off sticking to a longer-term loan — even if that means having to spend more money on interest over time.
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