It has been a slow and painful process, but the housing market is now in recovery, and foreclosures have been dropping. Since the housing bust, regulators have focused on preventing borrowers from taking out potentially toxic loans. To help accomplish this, the U.S. government established the Consumer Financial Protection Bureau in 2010.
As part of this effort, the CFPB has proposed new disclosure forms to help borrowers understand the real risks and costs associated with their mortgage. But many potential borrowers are still unsure about the type of mortgage that is right for them. Many borrowers are attracted to 15-year mortgages' shorter term and lower interest rates compared with 30-year mortgages.
But although the 15-year mortgage has been rising in popularity, it is not necessarily for everyone. For borrowers, it's important to get as much information as possible about the different common mortgages that institutions offer — and to understand the different terms. While the amount being borrowed, or principal of the loan, is often clear, the cost of the loan, or interest rate, is often less so.
In an interview with 24/7 Wall St., Guy Cecala, publisher of Inside Mortgage Finance, said borrowing to buy a home is a more complicated decision than refinancing. It is “much more of a calculation about what you can afford, how secure you are about your job, what’s the likelihood you’re going to want to move in less than five years.”
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Borrowers must understand how payments, which consist of principal repayment and interest, will be structured under the different types of mortgages. They need to consider how much they will be paying for the loan, not just now, but in the future as well. And they should also consider their budget, age and other factors before deciding on a mortgage.
These are the questions to ask when deciding between a 15- and 30-year mortgage.
1. Can you afford to pay off the mortgage in 15 years?
“If you can afford the higher payments associated with the shorter-term 15-year mortgage, there is no reason not to take one,” Cecala said. The rate is lower for a 15-year mortgage compared with a 30-year mortgage, which means you're paying less interest and paying it for only half as long.
But a 15-year mortgage comes with a higher total monthly payment (because the principal is paid off so much faster). Higher monthly payments can strain borrowers’ ability to set aside money for retirement or their kids’ college tuition. These borrowers may be better off with a 30-year mortgage.
Similarly, if the higher payments of a 15-year mortgage mean that borrowers have less money to invest elsewhere and diversify their portfolios, they may be better off with a 30-year mortgage.
2. Are you buying your first home?
First-time home buyers often benefit from the lower monthly payments of a 30-year mortgage because it puts a pricier home within reach. Most first-time home buyers “are trying to get in as much house as they can,” Cecala said.
And fixed-rate mortgages are not the only options. Borrowers can take an adjustable-rate mortgage, which offers a low initial rate -- again, lower still for a 15-year compared with a 30-year -- but after the initial rate expires, borrowers are subject to prevailing rates and may well have to pay more. (No one thinks rates are likely to stay this low for long.) For buyers who are not looking to own their home for too long and who are confident that they will be able to resell the home, an adjustable-rate mortgage may be sensible option.
3. Are you looking to refinance?
The trend toward refinancing may have waned, but millions of Americans are still leaving billions of dollars on the table. Depending on how high your current 30-year rate is, you might be able to refinance into a 15-year mortgage while keeping your monthly payments about the same and shortening your mortgage term.
An additional factor that may make refinancing more attractive is the current difference between interest rates on 15-year and 30-year mortgages. Historically the spread has been about a quarter of a percentage point, Cecala said. But at the moment, the spread is especially large -- close to a full point in some cases.
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4. Are you planning to retire soon?
Typically, borrowers who take 15-year mortgages are at least 40 years old, according to Cecala. These borrowers are often willing to pay off the balance on their mortgages faster in order to retire with little or no outstanding debt on their homes. According to the CFPB, 30% of homeowners aged 70 and older have outstanding mortgages.
However, homeowners also must weigh their desire to pay off their mortgage against their need to save for retirement.
5. Do you have a strict savings plan?
If you're not a disciplined saver, a 15-year mortgage may be a smarter option than a 30-year mortgage, because it essentially forces you to save.
If you are a truly disciplined saver, you may actually benefit from carrying a mortgage into retirement. A Time magazine story this past spring advised that “if you expect to earn more after tax on your investments than you pay after tax on your mortgage, keep the mortgage.” What you want to avoid in retirement, however, is a situation where you are juggling a mortgage on top of your basic costs of living, taxes and health care payments.
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