Trying to make sense of all of the different choices that are available when it comes to mortgages is challenging. In fact, it is something that most people struggle with.
15-year fixed-rate conventional mortgages are some of the most popular options out there. To decide whether or not one of these loans is right for you, it is important to learn more about how they work
As you might guess, these loans are designed to be paid off over a period of 15-years. During that time, the interest rate never changes, which is why it is called a fixed-rate loan. Loans like these conform to the standards established by the Federal National Mortgage Association (FNMA). This organization, which is more popularly referred to as Fannie Mae, is one of the biggest purchasers and guarantors of mortgages in the country.
When compared to other types of loans, how does this mortgage option measure up? Learning more about these loans can help you get a deeper understanding of the benefits that they offer.
An Introduction To 15-Year Fixed-Rate Mortgages
Conventional mortgages with fixed interest rates have earned the nickname “vanilla wafer” mortgages. Like the basic, no-frills cookies that inspired this nickname, the mortgages themselves are uncomplicated and easy to grasp.
The loans themselves provide a well-defined framework for financing a home. Borrowers put anywhere from 5 to 20% down on the home. They then get a mortgage that is paid off over a specific number of years at a predetermined interest rate that doesn’t fluctuate over time.
If you plan on taking out one of these loans, you should put down a minimum of 20% on your new home. If your down payment is any lower than that, you will be required to pay for private mortgage insurance (PMI). Typically, this insurance is calculated at a rate of 0.5% of the loan on an annual basis. To get a better idea of how this can impact your mortgage payment, imagine that your loan is for $250,000. If you are required to pay for private mortgage insurance, it will add approximately $104 to your monthly mortgage payment.
Fixed-rate mortgage loans are made up of two primary parts – the interest in the principal. With any loan, the amount of money that you borrow is referred to as the principal. The interest, on the other hand, is a specific percentage of money that you are required to pay the lender as a way of compensating them for loaning you the money.
With fixed-rate mortgages, the interest rate stays the same throughout the entire term of the loan. The only thing that varies is the amount of time that you have to pay back the money. Fixed-rate loans for homes are available with terms ranging from 10 years to 50 years. The most popular and commonly available options, however, are 15-year and 30-year loans.
From 2004 to 2014, the Bureau of Labor Statistics found that 15-year fixed-rate mortgages were used to buy properties by 14% of homebuyers, making them the second most popular type of mortgage. By way of comparison, 30-year fixed rate mortgages, which were the most popular option, where used by 61% of homebuyers. Their popularity stems largely from the fact that they offer lower monthly payments.
People often mistakenly believe that 30-year loans are the best option since they are the most popular. As it turns out, however, there are a lot of drawbacks associated with taking out a 30-year mortgage.
The Benefits Of A 15-Year Mortgage
Paying cash for a home is almost always the best choice. Unfortunately, that isn’t always possible. If you do need to borrow money from a bank, experts like the ones at Texas Mortgage Pros generally recommend going with a 15-year fixed-rate mortgage. When buying a home, you should put a minimum of 10% down. Ideally, however, you should wait and save up a 20% down payment. When figuring out how much you can afford to spend, choose an amount that keeps the total amount of your monthly mortgage payments lower than a quarter of your after-tax income.
To understand why 15-year fixed-rate mortgages are the ideal choice, consider the benefits that they offer, which are listed below:
1. Your Mortgage payments and interest rate won’t fluctuate over time.
The payments that you make on a 15-year fixed-rate loan include both money for the principal and money for the interest. Because the loan has a fixed interest rate, you don’t have to worry about the number of your payments changing over time. Instead, apart from the cost of insurance and taxes, your monthly payments will stay the same over the entire loan term.
This is extremely beneficial since it protects you from future increases in interest rates. If you start with a loan payment of $1,500 a month on your mortgage, that payment amount will stay the same over the life of the loan, even if significant changes occur in the housing market. Of course, you can always pay more than that if you want to pay your loan off more quickly.
2. The interest rates on 15-year fixed-rate mortgages are usually lower than other types of loans.
The amount of interest charged by the lender on 15-year fixed-rate loans is usually lower than other types of mortgages. This has to do with the amount of risk involved in the transaction. Because these loans have a shorter term, borrowers are less likely to default. Due to the lower level of risk, lenders can charge less interest.
By way of comparison, the interest on 15-year loans is usually anywhere from about 0.25% to 1% less than what you would pay if you had a 30-year mortgage. Even though that doesn’t sound like a significant difference, spending that much less in interest over the life of the loan can wind up reducing the total amount of money that you pay for your home by thousands of dollars.
As a bonus, if you go with a conventional 15-year fixed-rate loan, you won’t be charged extra fees like you would if you chose an FHA or VA loan that was backed by the government.
3. These loans can save you a tremendous amount of money.
One of the biggest mistakes that people make when buying a home is focusing on how much money they have to pay each month rather than on how much money they have to pay over the life of the loan.
Even though the monthly payments for 15-year fixed-rate loans are higher than what you would pay if you had a 30-year mortgage, the amount of money that you can save over the life of the loan is truly phenomenal.
As an example, imagine that you are interested in buying a home that costs $250,000. The two first borrowing options you are considering are taking out a 15-year fixed-rate mortgage or opting for a 30-year fixed-rate loan instead.
If you were able to obtain a loan with an interest rate of 4.18%, your payment on a 15-year fixed-rate mortgage would be $1,872. Alternatively, if you took out a 30-year fixed-rate loan that had an interest rate of 4.76%, you would wind up paying $1,306 each month – a savings of $566 per month. Even though it may seem like the 30-year fixed-rate loan is a better deal, these numbers aren’t telling the full story.
To determine the actual cost of the loan, you should look at the total amount that you have to pay over the life of the loan. With the 30-year loan, you would wind up paying $130,000 more than you would with the 15-year loan by the time you were done paying off your mortgage. This difference comes from the amount of interest that you have to pay on the loan. To put things in perspective, think of it this way: with the extra money that you pay on a 30-year loan, you could practically by another house outright.
4. The amount of equity you have in your home increases more quickly with a shorter loan term.
Home equity is determined by calculating how much money you owe on your home versus how much it is worth. When you have more equity in your home, it means that you own a more significant percentage of the current value of your property. Paying down the loan’s principal more quickly allows you to gain equity at a faster rate.
Ultimately, your goal should be to apply as much of your monthly payments as possible to the principal amount that you owe rather than the interest. This will help you increase your equity more quickly. Because 15-year rate mortgages have a shorter loan term, a higher percentage of each payment goes to the principal of the loan. This allows you to build equity in your home more quickly.
With 30-year loans, on the other hand, the first few years that you pay on your mortgage, the vast majority of each payment is going to the interest. As a result, you don’t build equity in your home as quickly.
Try using the provided mortgage calculator to determine the amount of each monthly payment that is being applied to the principal rather than the interest on your loan.
Advice on Mortgage Refinancing
You might have heard that a 15-year fixed rate mortgage is a fully amortized loan, but the truth is that it is a fancy term that describes the process of debt payment with a planned incremental schedule of repayment. This means that if you make your scheduled payments on a 15-year mortgage, your loan should be paid off by the end of the 15-year period.
On the contrary, a 30-year mortgage will leave you in debt an additional 15 years, meaning you will spend an extra 15 years in bondage to a lender. Here is an example of what taking that route might cost you:
If you choose to invest $1800 monthly payment into stock mutual funds for the next one and a half decade after the end of the 15-year term, it is possible to add around $700k to $900K to your retirement fund. This is certainly way better than 15 additional years of loan payments.
It is not advisable to get a mortgage that goes beyond 15-years as you are simply throwing your time and money away.
So, When does 15-year Fixed Rate Mortgage Refinancing Become a Good Option?
Perhaps you are thinking that this information could have been useful a long time ago, but you already have a 30-year mortgage. Maybe you are stuck with an interest only or adjustable-rate mortgage and do not like the fluctuations of the interest rates. If you fall in any of these categories, then mortgage refinancing certainly makes sense.
Basically, refinancing your mortgage redefines the terms of your initial loan in order to create a new one. If it shortens your overall payment schedule or lowers your interest rate, it is worth considering. However, before you make the move, there are a few things you should know;
When To Refinance
Remember that the primary goal of refinancing is to make an undesirable mortgage loan by getting a 15-year fixed rate one with a new payment that does not go beyond 25 percent of your income.
Mortgage refinancing makes sense if you are in one of the following categories:
- Have an interest only mortgage
- Have an adjustable-rate mortgage or ARM
- Have a high-interest mortgage
- The mortgage term is more than 15 years.
If you have a 30-year mortgage with a high-interest rate, the gains you make by taking a 15-year fixed rate mortgage through refinancing are a huge benefit. The monthly payment might be high, but it is overweighed by the advantage of paying off the debt earlier and saving thousands of dollars during the process. However, do not forget to consider the closing costs of a loan refinance, which can go up to 6% of the loan amount.
When To Avoid Refinancing
If you have a favorable interest rate on your current mortgage, applying for a refinance loan simply is not worth it. Consider using our mortgage payoff calculator in order to find out your monthly payments if you want to pay off the loan in 15 years.
The most important thing is to remain focused and keep making the extra monthly mortgage payments. If you stick to this plan, you can be able to pay your 30-year mortgage in just 15 years and you will get out of bondage faster than you initially thought.
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