15-Year Loans Can Save Interest While Building Equity
Robin and Marilyn Caires liked the idea of being forced to save for retirement. That’s one of the reasons they recently refinanced their Burbank home with a 15-year mortgage, said Robin Caires, a 58-year-old computer analyst. “We wanted to have more of our mortgage out of the way by the time we retire,” he said. “We view it as enforced savings.”
Although monthly payments are higher on 15-year loans, the Caires can afford to pay off their mortgage in 15 years versus the usual 30 years because they borrowed only about $192,000 on their $400,000 home. By doing that, the Caires get to pay off their home more quickly, and they also benefit because interest rates on 15-year mortgages generally run half a percentage point less than longer-term loans.
Despite the fact that 15-year mortgages are a way to save a great deal of money in interest payments, the Caires aren’t exactly at the vanguard of a major trend. If anything, the uncertain economy has made many borrowers less likely to commit themselves to a higher mortgage payment. But, for those left with extra money every month, a 15-year loan can mean early freedom from mortgage payments.
“It’s a fairly simple decision. If you have the income to afford the 15-year payment, it’s worth it because you save a ton of interest,” said Earl Peattie, president of Mortgage News Co. in Santa Ana. A $200,000, 30-year loan at 7% would cost a borrower $1,361 a month in principal and interest payments. A comparable 15-year loan at 6.5% would be $1,742 a month. For borrowers with the extra $381 a month, Peattie said, the 15-year loan can make lots of sense.
Borrowers have another option too, Peattie said. Instead of committing to a 15-year loan, they can instead get a more typical 30-year loan and just commit themselves to accelerating principal payments voluntarily. The advantage is that the borrower isn’t locked into the higher monthly payment obligation.
There are some drawbacks, however, Peattie said. First, the 30-year borrower won’t be able to get as low an interest rate as the 15-year borrower. And, when borrowers voluntarily add to their monthly payment, the lender doesn’t always properly account for the additional funds. “The computer software most lenders are using is not always as accurate as you’d like it to be, so you need to keep track of the extra payments yourself in order to audit the lender’s calculations,” Peattie said. “You must also save every bill and every check that you write. It’s critical if you need to go back and audit the loan.”
New Freedom Financial Inc. in Simi Valley offers 15-year mortgages, and what it calls an equity builder loan, where a borrower may voluntarily make additional principal payments each month to accelerate the mortgage. “People don’t want to lock themselves into a higher payment for 15 years,” said William J. Tessar, president of New Freedom Financial. That’s made his voluntary equity builder more popular, he said.
What many borrowers don’t realize, Tessar said, is that when they write a bigger than usual check to their lender, the money may not be eliminating any future payments or advancing the loan’s amortization schedule. Many lenders simply put the extra money into an escrow account, a so-called unapplied account or a reserve account, usually bearing no interest at all.
When making an extra payment on a 30-year loan, for example, Tessar said it’s essential for the borrower to send a notice to the lender explaining exactly how the extra payment is to be applied to the mortgage. New Freedom Financial provides borrowers with just such a form, Tessar said, but the borrower is required to make an exact payment of each extra month’s principal. This, Tessar said, helps avoid future accounting nightmares.
“Most people don’t have the luxury of considering 15-year loans,” said John Lucas, vice president and branch manager at ARCS Mortgage Inc. in Van Nuys. “It comes down to whether the borrower is comfortable with the higher payment.” The savings can be startling. With the same $200,000 loan example above, a borrower in the first year of a loan will pay off about $2,000 in principal on the 30-year loan versus about $8,000 on the 15-year equivalent.
While many borrowers will refinance, or not stay in the homes for the full term of any loan, the accelerated payments of a 15-year loan are a good way to build equity.
But there are some very legitimate reasons for not choosing a 15-year loan. Interest rates remain close to a 20-year low and many borrowers want to lock into the longest possible fixed-rate loan. Also, 15-year loans are generally not available with an adjustable interest rate. Most people who opt for an adjustable rate want to start with low payments, so a 15-year adjustable would be something of a contradiction. Finally, there are many borrowers who want higher mortgage interest payments, because all the interest is tax-deductible.
“Most financial planners and CPAs don’t recommend 15-year loans because there’s less of a tax write-off and because most people prefer investing their discretionary income in something other than their mortgage,” said Suzanne Shirley, district sales manager for California Federal Bank in Reseda. That helps explain why more than 85% of borrowers opt for the usual 30-year loans.
Most 15-year borrowers are in their 40s or 50s and they are secure in their careers, Shirley said. These days, she said, not too many people are feeling very secure. “In this economy, folks are looking for more immediate ways to maximize their discretionary income,” she said.
