For reasons that no one understands, the 30-year fixed-rate mortgage is still the dominant choice for most borrowers in the US. Honestly, the fact that everyone has 30-year fixed-rate mortgages may be a major contributor to the growing wealth gap in our country. So, the question above is should you choose a 30-year fixed? The short answer is ‘NO’. In this article, though, we’re not only going to cover why you shouldn’t choose a 30-year fixed, we’re also going to talk about situations where a 30-year fixed might be tempting. We’ll also talk about the only circumstances that might actually make the 30-year fixed your best option.
How the 30-Year Fixed Compares
Let’s crunch the numbers to show you exactly why a 30-year fixed is literally the worst option you could choose. Since we specialize in VA loans, we’ll be including the VA hybrid ARM as one of your options. If you are not eligible for VA loan benefits, you can still get a conventional ARM that is similar but not as good as the hybrid ARM. So, for this comparison we will be pretending that you are buying a home for $200,000, not making a down payment, are paying closing costs upfront, and are getting today’s mortgage rates. We’ll show you how the numbers go with a 30-year fixed, a 15-year fixed, and a 3/1 VA hybrid ARM. First we’ll take a look at the available interest rates.
For the record, interest rates right now are insanely low. Even with how low-interest rates on a 30-year fixed are, they are still the highest option. If you live in Salt Lake City, as of today, your lowest interest rate offer on a 30-year fixed is 3.87%. On a 15-year fixed, you could get as low as 3%, and on 3/1 VA hybrid ARM, you could get a starting rate of 2.25%. We won’t talk too much about the ARM in this article, but you should know that the VA hybrid ARM is actually really awesome, and it’s very likely that the hybrid ARM is the best loan option for you. Just comparing interest rates across the board, though, you can see that the 30-year fixed gives you the highest interest rate.
Unfortunately, 30-year fixed rates not only charge a higher interest rate, they also charge that rate for twice as long as a 15-year fixed! So not only are you paying more in interest each month, you’re paying it for twice as many months. It’s like a double whammy of horribleness. So how do the numbers play out over the life of the loan? It’s hard to estimate the ARM since it adjusts and there’s no way to predict how rates will change over time. For the 15-year fixed and the 30-year fixed, however, it’s very easy. On a 30-year fixed on a $200k home, you’ll pay $138,366 in interest over the life of the loan. In other words, you’re paying $338,366 for a $200k home. Want to know what makes that even worse? Because of amortization, you’re paying most of that interest in the early years of the loan. Since you will almost certainly refinance or move every 5-6 years, it’s very likely that you will never reach the point where you’re paying more towards principal each month than interest – even with a historically low-interest-rate like 3.87%.
Now let’s take a look at the 15-year fixed. You can get a straight 3% interest rate on a 15-year fixed. How much of a difference does that make? Nearly $100,000 of difference. On a 15-year fixed you’ll pay $48,610 of interest on a $200k home. Still a lot of money, sure, but compared to $138,366? That’s a no-brainer.
Many people think that their monthly payment will double if they go from a 30-year to a 15-year, but this is not the case. The monthly payment will certainly be higher, but most of that is added principal. Most of the times that I have compared specific home prices and interest rates between 30-year and 15-year options, I have found that the 15-year monthly payment is usually about half-again the payment on the 30-year. So if the 30-year payment is $900, the 15-year will usually be around $1,350 (900/2=450, then 450+900). This can change a lot depending on the different interest rates offered at each term.
We didn’t talk much about the ARM, but the ARM usually beats the 15-year fixed, regardless of whether you refinance or move every few years or stick with it. Check with one of our loan officers to learn more about the ARM or the 15-year fixed.