With so many options available to finance a house, choosing the best one can be intimidating. One factor in that decision that can greatly alter the final costs of home ownership is the term of the loan. Most loans have terms of either 15 years or 30 years. This time frame is called the "life of the loan."
The shorter the life of the loan, the lower the interest rate that will be charged for it, in most cases. Currently, Freddie Mac reports the average rate for a 30-year loan at 5.31 percent and for a 15-year rate it's 4.73 percent. Keep in mind also that the 15-year option will have the borrower house payment-free in half the time.
Calculating the estimated monthly payment on a particular house is easy in the Internet millennium. Most real estate and mortgage lending sites have calculator tools for potential borrowers to get an idea of their out-of-pocket monthly expenses.
Fannie Mae, a government-sponsored secondary lender, offers a "True Cost Calculator." It allows the user to plug in characteristics for two different mortgages and compare costs. Using Freddie's most current interest rate averages, the savings over the life of a $150,000 loan are substantial. For comparison purposes, a 20 percent downpayment is assumed.
According to the True Calculator results, for a $120,000 loan, payments on a 15-year mortgage are $932.16. For the 30-year loan, the monthly bill is markedly lower, at $667.11. But the cost for the 30-year loan, after making all 360 payments is $240,160. The 15-year loan ends up costing $167,789, a life of loan savings of $72,371.
In addition to the lower interest rate and the early out, another factor in favor of the 15-year rate is the equity buildup in the property. The True Calculator reveals total equity seven years into the payment schedule. In this example, a 20 percent downpayment was assumed, so the equity at the beginning of the loan was $30,000. With a 15-year note, a homeowner has an equity level of $75,616 (not including any rise in property value). The individual with the 30-year loan has a substantially lower stake in his residence, owning only $43,811 of the total.
Seven years into the loan, the borrower with the 30-year note has averaged about $164 a month toward principal, while the borrower with the 15-year loan averaged about $543 towards principal per payment. Because the ratio of interest to principal varies from payment to payment, different time frames will result in larger or smaller chunks of the payment satsifying principal. Even so, seven years into payments, the difference between the 30-year monthly payment and the 15-year monthly payment, $265, that the 15-year borrower pays each month all heads to the principal column of the repayment schedule.
When the 15-year mortgagee pops the cork on the freedom-from-house-payment champagne, the 30-year mortgage holder will still have 15 years and $82,662 in monthly loan payments left to go.