When looking to purchase a home, many people choose a 15 yearover other options. Since the loan will be paid down more quickly than other options, it is often preferred by lenders. Because of this, a 15 year comes with a fixed payment and lower interest rates than other loans.
Comparison to Other Options
While the 15 year is one of the more popular mortgages, there are several other products which are available. A 15 year can be compared to the following:
- 30 year mortgage – The 30 year is the most frequently used option. Like the 15 year, the 30 year has a fixed payment over the life of the loan. The main difference is that the 30 year is paid over a period twice as long, which leads to lower monthly payments. However, the 30 year always comes with a higher interest rate which ranges from 0.50% to 0.75% higher than a 15 year.
- Adjustable Rate Mortgage (ARM) – Another common product is an ARM. With an ARM a borrower receives a low initial interest rate and fixed payment for a set period of time, which normally ranges from 1 to 7 years. After the initial period, the interest rate adjusts to a different rate, which can be unaffordable for some people. Depending on the length of the initial interest rate period, an ARM will come with an interest rate of 0.25% to 0.50% below a 15 year's interest rate.
- Jumbo Mortgage – A jumbo mortgage is designed to finance more expensive homes. Jumbos are required for balances exceeding $417,000, although it was raised to $729,000 temporarily. Since jumbos provide more risk to the bank, they often come with higher interest rates. 15 year jumbos typically come with an interest rate of 1% above a traditional 15 year loan.
What Affects Interest Rates
Like all mortgage products, the best time to get a 15 year is when interest rates and fees are low. Interest rates are affected by a few different factors. The main factor which affects rates is supply and demand. Supply and demand is a basic economic principle which affects almost all everything in a free market economy. In a good economy, interest rates tend to be higher because more people can afford to purchase a home and the demand increases. In a poor economy, rates tend to be lower because less people are looking to purchase a home which leads to a lower overall demand.
Mortgage rates can also be affected by governmental actions. In the past, the federal government has invested heavily in Freddie Mac and Fannie Mae so the two giants would keep their interest rates low. Also, in situations when an economy is improving, the federal government is forced to increase federal interest rates to prevent drastic inflation. Increasing federal rates has an indirectly impact which will increase mortgage costs. Home loans are typically priced against 10 year Treasury notes, as most people tend to sell or refince every 5 to 7 years.
Benefits of a 15 Year
There are many benefits of selecting a 15 year loan. Some of the main benefits are:
- Low Interest Rate – As mentioned earlier, a 15 year normally comes with an interest rate of .50% to .75% lower than a 30 year rate. Coupled with the fact that the loan is paid off much quicker, a 15 year will save a borrower thousands of dollars each year in interest payments. Over the course of a $200,000 loan, a borrower will save $147,000 by selecting a 15 year over a 30 year.
- Build Equity Quickly – Another benefit of selecting a 15 year is that a homeowner will build home equity much quicker than someone who selects a 30 year. Assuming a $200,000 loan with interest rates of 6% for a 30 year and 5.25% for a 15 year, after just five years a borrower with a 15 year will have $35,000 more equity in their home than a person with a 30-year. After the 15 years, a person with a 30 year will still have $144,000 pinciple balance left.
- Fixed Payment – Another benefit of a selecting a 15 year is that the borrower will have a fixed payment for the life of the term. Because of this, a borrower will be assured that their payment will never adjust dramatically and they will always have an affordable payment.
While a 15 year comes with many advantages and is ultimately a very cheap options, many lenders attempt to throw in hidden costs which could cost a borrower thousands of dollars. Some hidden costs to look out for are as follows:
- Points – A hidden cost that many lenders attempt to lump into a 15 year is mortgage points. Lenders often offer borrowers very low interest rates, but to make the loan more profitable they try to add in points which are either paid at closing or lumped into the monthly payment. The points normally cost about 1% of the loan balance, but can save up to .125% off the interest rate.
- Balloon Payments – A balloon payment is a hidden cost that some lenders attempt to throw into their agreements. In these agreements, a lender will require a borrower to payoff the entire outstanding balance at a certain point in time. If it can’t be repaid or refinanced, the lender may throw the loan into default and foreclose on the home.
- Pre Payment Penalties – Another hidden cost, which is rather rare, is pre-payment penalties. A pre-payment penalty is a penalty that prevents a borrower from paying off their home before a certain date. Many pre-payment penalties phase out after 3 to 5 years, but can still cost as much as 2% of the loan balance. A pre-payment penalty can be disadvantageous if the borrower wants to refinance their mortgage or if they sell their home.