30 vs 15 year mortgage - pros and cons

With any financial investment you need to look at home ownership from both a short- and long-term perspective. Choosing a 30-year mortgage versus a 15-year mortgage can dramatically impact you financially -- for better or for worse. Based on your individual circumstances, it's important to review the key differences.

30-Year Term
The 30-year term offers you budget flexibility and the opportunity to qualify for a larger mortgage. You can also spread your mortgage payments over an extended period, offering the advantage of reduced monthly payments, e.g., on a $150,000 mortgage, your payments would amount to roughly $330 per month less than the payment for a 15-year term.

You still have the option to prepay your mortgage each month and reduce the term of a 30-year mortgage (assuming you do not have a prepayment penalty clause). However, if you incur an unexpected bill or simply have less cash flow in a given month, a 30-year term allows you the flexibility not to prepay your mortgage.

The tradeoff to having financial flexibility with the 30-year term is that you will pay a slightly higher interest rate and accumulate equity at a slower rate.

15-Year Term
The primary attraction of a 15-year term is that it allows you to pay off your mortgage within 15 years. To many homeowners, a shorter term may offer an overwhelming advantage – savings in time and capital, not to mention piece of mind. Another plus of the 15-year term is the interest rate is roughly a ¼ to 3/8% lower than the prevailing 30-year term.

However, a 15-year term does have its disadvantages. The 15-year's higher monthly payments can reduce your purchasing power. Looking again at the above example, the $330 per month (saved) in a 30-year term is roughly equivalent to $50,000 in buying power. Qualifying for an extra $50,000 could be the difference between an acceptable but ordinary home and the home of your dreams.

What are your spending habits?
Reviewing the basic differences described here, the choice between a 30-year and a 15-year term may not be entirely clear. Assuming either option is realistic given your personal budget, your choice may ultimately be based on your personal spending habits.

For those homeowners who mistake a savings plan for excess "play money," you may be better off choosing a 15-year term and creating a “forced savings plan.” On the other hand, if you are a diligent saver and usually earn a higher return on investments than your current mortgage rate, you may benefit financially by choosing the 30-year term and investing the difference.

Best of both worlds
If you are unwilling to commit to a 15-year term but would like the “forced savings” associated with the15-year term, here is a helpful hint: Most mortgage companies will allow you to set up automatic payments from your checking or savings accounts. Call your mortgage consultant and ask them to calculate the required amount beyond your normal monthly payment to payoff your mortgage in 15 years (or whatever timeframe meets your goals).

To calculate the new payment, your mortgage consultant will need a ballpark estimate of your current mortgage balance, your current interest rate and when you would like the mortgage to be paid off. When setting up the automatic payment, simply select the new payment amount. As mentioned before, if you run into a cash flow issue or can make better use of your money elsewhere, you are free to cancel the automatic deduction and revert back to your original monthly payment.

Summary
To recap, a 30-year term offers lower monthly payments, more flexible payment options and the ability to qualify for a higher mortgage. A 15-year term offers a lower interest rate, accelerated accumulation of equity and a forced savings plan. As with any financial decision, consulting your accountant/financial planner as well as your mortgage consultant will help you determine the best mortgage term for your individual goals and needs.