Home prices have remained high, with the median sale price reaching $383,725, a record high, according to Redfin. For such a major purchase, it makes sense to explore all the ways to cut down on costs. The interest rates on a 15-year mortgage are usually much lower than for a 30-year loan, saving you money over time. But since you're repaying the mortgage in half the time, monthly payments can be much higher.
The higher monthly payments could be one reason why homebuyers are choosing other term lengths. According to the Federal Reserve Bank of St. Louis, just 10% of new mortgages issued are for 15-year terms. Consider both the pros and cons of these shorter-term mortgages to find out if it's a good fit for you.
Pros and cons of a 15-year mortgage
Completely paying off your mortgage in just 15 years can be particularly attractive to homebuyers who have the funds to cover both the sizable monthly payments and their other expenses.
Consider your financial situation when you decide which loan term works for you. “It can be exciting to pay a mortgage off quickly and build equity in a home, but you need to make sure you will be able to balance a higher mortgage payment with all of the other expenses in life,” said Caroline Tanis, CDFA, financial adviser at Tanis Financial Group.
While 15-year loans can save you money over the life of the loan, 30-year terms are more common. Freddie Mac reported that almost 90% of homebuyers opt for a 30-year term. Consider your finances when you weigh which term is best:
When you calculate how much house you can afford, look at your monthly income compared to monthly debt payments. You can also use a mortgage calculator to compare 15- and 30-year terms to see what your payments would be.
For example, if you enter a loan amount of $200,000 over 30 years with a 7% interest rate, the monthly payment would be $1,330.60 and the total cost of the home would be $479,016. If you change the term to 15 years, the monthly payment climbs to $1,797.66 and the total paid over the life of the loan drops to $323,578.80.
Once you know what your budget is, you can explore your options.
Several factors impact your mortgage rate, no matter how long the term lasts. Here are the most important factors a lender looks at and how you can improve them:
- Credit score: It's hard to quickly improve your credit score unless you have a major mistake listed on your report. You can improve your score over time if you pay all of your monthly bills on time and pay down revolving debt. You should start seeing incremental changes each month.
- Down payment: A larger down payment helps lower your interest rate because you're more financially vested in your new home. Ask your lender for rate quotes based on different down payment options you're considering.
- Debt-to-income ratio (DTI): Income alone isn't enough to qualify for a low rate. You also need an appropriate level of debt. Many lenders will want you to have a DTI below 45%. You can calculate yours by adding up your monthly debt payments — including credit card balances, car loans, student loans, and your expected mortgage payment — and dividing the total by your gross monthly income.
There is no minimum credit score required specifically for a 15-year mortgage, but you'll need to meet the credit requirements of the type of loan you choose. Conventional, FHA, and VA loans offer 15-year terms but have different credit requirements. Your credit score influences your rate, so a higher score will help lower your monthly payments.
Once you receive a loan offer, most lenders lock in the quoted rate for a period of time until closing. This could be 30 to 60 days (or longer depending on the lender). Even if rates climb, you'll get the original rate if you close within the rate lock period. The downside is that if rates go down, you may be stuck with the higher rate. You could negotiate a free "float down" that lets you change your rate if they drop before you close.
There are a lot of factors to consider when choosing between a fixed-rate and variable-rate mortgage. A fixed-rate loan gives you the peace of mind that your principal and interest payment will not change over time. A variable-rate mortgage is typically lower to begin with, but resets after an initial fixed period. This means your mortgage payments could steadily increase in the future.
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