Dubai: When opting to finance your new home with a new loan, you would be faced with a key decision all home loan borrowers face – which is deciding between a 15-year or 30-year mortgage.
“Whether or not you are buying a home for the first time, you need to determine whether it makes more sense for you to get a 15-year mortgage or a 30-year mortgage,” said Dubai-based property consultant Andrew Bailey.
“While you will also need to decide whether you want a fixed rate loan or an adjustable rate loan, the first big decision you make has to do with the length of your mortgage term. In the end, the decision is usually made based on monthly cash flow.”
The first big decision you make has to do with the length of your mortgage term. In the end, the decision is usually made based on monthly cash flow
What is the biggest advantage of a 15-year mortgage?
Bailey agrees that the biggest advantage of the 15-year mortgage is that you can save money over the life of your home loan. “Not only do you have the loan for a shorter period of time, but you also usually have a lower interest rate,” added Bailey.
Consider a Dh200,000 loan. A 15-year mortgage has a rate of 2.6 per cent fixed, and a 30-year mortgage has rate of 3.4 per cent fixed. This calculation doesn't include insurance and other costs that might come with a mortgage like utilities and maintenance.
With a 15-year mortgage, your total on that loan would be Dh241,742.46. The total on a 30-year mortgage would be Dh319,306.49. You can see that you save a great deal by choosing a 15-year mortgage. Plus, you pay off the mortgage much faster.
“It can be a great choice for someone who is interested in saving money and paying off the house as soon as possible,” explained Bailey. “The main downside with a 15-year mortgage is that you have a higher mortgage payment.”
In our scenario above, the 15-year monthly payment is Dh1,343.01. That doesn't include other costs, like insurance, utilities and maintenance. Compare that to the Dh886.96 monthly payment that comes with a 30-year mortgage.
How cost-effective is a 30-year mortgage over a 15-year one?
30-year mortgages are popular mainly because they are more affordable on a monthly basis. “When you get a 30-year mortgage, you can usually shave off between Dh300 and Dh500 a month, depending on the interest rate and the size of the mortgage,” said Rupesh Naish, a debt consultant based in Dubai.
“For someone just starting out, a 30-year mortgage is desirable because it makes the home more affordable. Many couples buying a first home have a hard time affording the monthly payment associated with a 15-year mortgage.”
Another advantage of a 30-year mortgage is that you have a certain degree of flexibility — even if you can afford the payments associated with a 15-year mortgage.
One way multiple experts recommend is to make 15-year loan payments with your 30-year mortgage. What this means is, even though you have a lower monthly payment, you can pay more each month, applying the extra toward the principal (main borrowed amount).
“If you are interested in paying off your loan as quickly as possible, there is nothing preventing you from making payments as though you have a 30-year loan. If you run into financial trouble, you can stop making your extra payment, and return to the payment that you agreed to,” added Naish.
“With a 15-year mortgage, you are stuck with that higher payment — no matter what. If you miss payments because of financial difficulty, you run the risk of foreclosure. If all you need is Dh300 or Dh400 of breathing room for the month, and you are used to making 15-year payments on your 30-year mortgage, you have that option to cut back without jeopardising your credit rating or your home.”
For someone just starting out, a 30-year mortgage is desirable because it makes the home more affordable
How do I decide which mortgage to get – 15- or 30-year loan?
Whether you choose a 15-year mortgage or a 30-year mortgage, it's important to make sure that you can handle your payments right now. “Even the lower payments associated with a 30-year mortgage can be a problem if the mortgage is just barely affordable for you,” added Bailey.
“In some cases, it's a straightforward look at the numbers. Can you afford the monthly payment with a 15-year mortgage? If not, you have little choice but to go with the 30-year mortgage. You can finance to a 15-year mortgage, with a lower rate and a higher payment, after your income situation improves.
“However, if you have income flexibility, weigh the pros and cons. Decide what is most important to you. If paying off your mortgage as quickly as possible is the most important consideration to you, a 15-year mortgage will force you into disciplining yourself to make those payments.”
At the same time, though, a 30-year mortgage can allow you the same ability by making extra payments while providing you with a level of flexibility in your payments.
“Another consideration is whether or not you really need to pay off your mortgage so quickly. While it sounds nice in theory to pay off your mortgage in 15 years, while building up equity, for many that isn't a particular concern,” said Naish.
“If you can lock in a low interest rate for 30 years, and then invest the money you are saving each month over the 15-year payment, you can actually come out ahead, depending on market conditions.”
For those who want to maintain cash flow flexibility, the best option is a 30-year mortgage.
A certain amount of peace of mind comes with a 30-year mortgage, too, since you know that you might be able to handle a payment if an emergency strikes.
However, if you want to lock in a lower interest rate, paying less and getting out of your mortgage sooner, a 15-year mortgage might be the better choice.