Flagging Economy Gives 15-Year Mortgages New Life

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NEW YORK (MainStreet) — For many borrowers, the 15-year mortgage is appealing at first glance but not after a closer look. Now though, these deals are more attractive than usual, thanks to their unusually low rates compared to the more popular 30-year loans.

This could make the 15-year loan the best option for borrowers who can handle the larger payments these loans require to retire the debt in half the time. Prime candidates are homeowners with lots of equity who want to refinance to reduce interest rates.

The average 15-year mortgage now charges 3.5%, or 80 basis points less than the average 30-year loan, at 4.3%, according to the BankingMyWay.com survey. That is an unusually large difference. At the end of 2008, for instance, the gap was less than 30 basis points.

A fraction of a percentage point doesn’t sound like much, but the lower rate can produce real savings over time. If the 15-year loan charged the same 4.3% as the 30-year deal, the borrower would pay $35,866 in interest over 15 years for every $100,000. Cut the rate to 3.5%, and interest would cost $28,679. The higher rate would increase interest cost by 25%.

By cutting the loan term in half, the borrower also eliminates 15 years of interest payments. For a $100,000 loan at today’s average rate, a 30-year loan would charge $78,154 in interest, versus the $28,679 for the 15-year deal.

The drawback, of course, is those bigger payments, caused by the faster principal repayment on the 15-year loan. For $100,000, the 15-year loan would cost $715 a month, versus $495 for the 30-year loan.

To offset that burden, the bigger principal payments not only save money over the long term, they allow the homeowner to build equity faster. After 10 years, the borrower with the 15-year loan would have a balance of just $39,297, compared to $79,574 for the borrower with the 30-year deal.

Assuming the bigger payment is not a problem, borrowers looking at 15-year loans should weigh two considerations.

First, if you took the 30 year loan with the lower payment, what could you do with the monthly savings?

With the 15-year loan, the larger sum going to principal effectively earns an investment return equal to the loan rate, or 3.5%, since it allows the borrower to avoid interest charges at that rate. (Or, the return could be thought to be 4.3% if you assume the 15-year loan allows you to avoid the interest rate on the 30-year deal.)

Either way, it’s not a bad return compared to bank savings and Treasury bonds. But banks and bonds might pay more in the future, and if you took the 15-year loan you’d be committed to putting extra money into the mortgage instead of other investments.

The second consideration: Should you split the difference and take out the 30-year loan, planning to retire it early by making extra principal payments? You would pay the higher interest rate but could still save substantial sums by paying interest for fewer years. With this approach, you would not be committed to the bigger monthly payments, which would be nice if money got tight or you found a bigger return with another investment.

To weigh these alternatives, use the BankingMyWay Mortgage Loan Calculator.

After running the numbers, many people decide that the big payment on the 15-year mortgage is too much of a strain. But some borrowers will find that today’s unusually low rates tip the balance, making the 15-year deal the best option.

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