What To Know If Considering A 15-Year Mortgage

By SCOTT SHELDON (Open Post)

One of the best ways, bar none, to eliminate your mortgage debt is moving into a 15-year fixed rate loan. With the average spread a full 1 percent compared to its 30-year mortgage counterpart, a 15-year mortgage can provide an increased rate of acceleration in paying off the biggest obligation of your life.

Does Your Picture Support The Load?

In most cases, you’re going to need strong income for an approval. How much income? The old 2:1 rule applies.

A 15-year fixed forces you to pay down the loan in half the amount of time, compared to a 30-year choice, and it effectively doubles up for each month of the 180-month term. Your income must support all the carrying costs associated with your home, including the principal and interest payment, taxes, insurance, (PMI only if applicable) and any other associated carrying cost. In addition, your income will also need to support all the other consumer obligations you might have as well, including cars, boats, installment loans, personal loans and any other credit obligation that contains a monthly payment.

The attractiveness of a 15-year mortgage in today’s interest rate environment has mass appeal.

The 1 percent spread in interest rate between the 30-year mortgage and a 15-year mortgage is absolutely real and, for many, the thought of being mortgage free can be very tempting. Consider today’s average 30-year mortgage at around 4 percent on a loan of $400,000 - that’s $287,487 in interest paid over 360 months. Comparing that to a 15-year mortgage interest over 180 months, a mere $97,218. That’s a shattering $190,268 in lowered interest.

But there’s a catch … your payment is going to be higher on your mortgage elimination plan.

The 30-year mortgage pencils out at $1,909 per month in principal and interest weighted against a 15-year mortgage $2762 per month in principal and interest, totaling $853 more per month, but going to principal. This is why the income piece makes or breaks the 15-year deal.

Independent of your other carrying costs and other credit obligations, the difference in income you’ll need works in the following way: $4,242 per month is enough income to offset just a principled interest payment on the 30-year fixed rate mortgage. Alternatively, to offset the principled interest payment on the 15-year mortgage you would need, $6,137 per month, essentially $1,895 per month more in income just to be able to to pay off your debt faster.

As you can see income is a large driver of debt reduction potential.

When Your Capacity Does Not Stack Up

Can you pay off debt? Lenders are going to consider the minimum payment obligations you have on all other credit obligations in the following way.

Take your total proposed new 15-year mortgage payment indicative of the loan amount and interest rate you’re seeking, and add that number to the minimum payment on all of your consumer obligations, and then take that number and divide it by .45 percent.

This is the income that you’ll need at the minimum to offset a 15-year mortgage based on whatever loan amount you have to work with. Paying off debt can very easily increase these numbers reducing the amount of income you might need and/or the size of the loan you might need, as there would less consumer obligations handcuffing your income that could otherwise be used towards supporting a stable mortgage plan.

Can You Borrow less?

Borrowing less money is a guaranteed way to keep a lid on your monthly outflow maintaining a healthy alignment with your income, housing and living expenses. Extra cash in the bank? If you have extra cash in the bank beyond your savings reserves that you don’t need for any immediate purpose, using these funds to reduce your mortgage amount could pencil very nicely in reducing the 15-mortgage payment and interest expense paid over the life of the loan. The concept of the 15 year mortgage is ”I’m going to have hammer, bite and chew and claw my way through a higher mortgage payment in the short-term in order for a brighter future.”

Can you generate cash?

If you can’t borrow less, generating cash to do so may open another door. Can you sell an asset such as stock, or trade out of a money market fund in order to generate the cash to rid yourself of debt faster? If yes, this is another avenue to explore, so long as your savings rate remains intact and preserved.

How about coming into additional funds via selling another property?

This should be examined more closely. If you have another property that you’ve been planning to sell, such as a previous home for example, any additional cash proceeds generated by selling that property, depending upon any indebtedness associated that property, could allow you to borrow less moving into a 15-year mortgage.

Ideal 15-Year Candidates

Consumers who are in a financial position to handle a higher loan payment while continuing to save money and grow their savings would be well-suited for a 15 year mortgage.

The other school of thought is to refinance into a 30-year mortgage and then simply make a 30-year, 20-year, 25-year or 15-year mortgage on the 30-year term anyway, which is another fantastic way to save substantial interest over the term of the loan. As cash flow changes, so could the payments made to the loan servicer, as prepayment penalties are virtually non-existent on bank loans.

Know this when you take out a 15-year mortgage: You also destroy your mortgage- interest, tax-deduction benefit. However, if you don’t need the deduction later on in 15 years anyway, the additional deduction removal may not be beneficial (depending on your tax situation and future income potential).

If your income is poised to rise in the future and/or your debt is planned to decrease and you want to have comfort in knowing by the time your small kids are teengers, you’ll be mortgage free, then a 15-year could be a smart interest savings move. Not to mention, when you’re mortgage is paid off, you will have control of all of your income again, as well.

Proximity to retirement is another factor borrowers should consider where carrying a mortgage into retirement is not part of the equation. These consumers might opt to move into a faster mortgage pay-off acceleration plan than someone buying a house for the first time, for example, who has many years of mortgage payments to make and might just be getting their foot in their door in their first starter home.

Other recent columns from Scott:

• Three Options First-Time Home Buyers Have To Get Started
• Here Are Several Reasons You May Be Denied A Home Loan
• Buying A Home? What Else Besides Your Income Matters?
• Applying For A Mortgage? That Will Not Tank Your Credit Score
• What You Need To Know About Getting A Mortgage In Today’s Environment
• Be Careful With Credit Cards When Buying A House
• Why A Short Sale House Is Still A Good Deal

Scott Sheldon is Senior Loan Officer and consumer advocate based in Sonoma County. Scott has been originating home loans for nearly decade. His weekly consumer articles offering key mortgage insight and credit tips can be seen in Yahoo! Finance, AOL Real Estate, Business Insider, Realtor.com, Fox Business, MSN Money and many others.

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