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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 entering into potentially toxic loans. To help accomplish this, the 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 may be attracted to 15-year mortgages, which have a shorter term and lower interest rates than 30-year mortgages. But this mortgage may not be right for their needs. (Bing: How low are interest rates this week?)
Despite the rise in popularity of the 15-year mortgage, it is not necessarily for everyone. For borrowers, it is important to get as much information about the different common mortgages 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.
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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.”
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 only now but also in the future. 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 and 15-year and 30-year mortgage.
1. Can you afford to pay off the mortgage in 15 years?
Although a 15-year mortgage offers a lower rate relative to a 30-year mortgage, thereby allowing borrowers to pay interest for only half as long, a 15-year mortgage comes with a higher total monthly payment. This is because the principal must be paid off faster, making each principal payment larger.
Because borrowers pay down the principal balance faster, in the longer run, they save on interest payments.
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“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.
Because the monthly payments are higher, however, it 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 borrowers have less money to invest elsewhere and diversify their portfolios, they may be better off with a 30-year mortgage.
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2. Are you buying your first home?
First-time home buyers often benefit from selecting a 30-year mortgage because the monthly payments are lower. A longer-term mortgage can make a more expensive home more affordable for a new buyer. According to Cecala, most first-time homebuyers “are trying to get in as much house as they can.”
Of course, 15-year and 30-year mortgages are not the only options available to consumers. Borrowers can take an adjustable-rate mortgage, which offers a low initial rate that stays unchanged for some period, such as five years. When the period expires, borrowers could pay more if interest rates rise. But 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 a sensible option.
3. Are you looking to refinance?
If you already have a mortgage and would like to refinance, now may be a good time. Cecala noted that if your current payments on a 30-year mortgage are high enough, you might be able to refinance into a 15-year mortgage and make similar monthly payments while shortening your mortgage term.