Ask WalletPop about home equity loans: Is 15-year or 30-year better?

A friend e-mailed me with a question about a home equity loan her family is considering. They're going through a credit union, and weighing whether to get a loan at a 15-year term, with 6.75% or Prime minus 50 bps, or a 30-year term with 7.00% or Prime minus 25 bps. "But we'll probably be selling the house in five years!" she said. "What should we do?"

I explained to her that when she was selling really shouldn't weigh into this decision; the terms of the home equity loan almost certainly indicate that it will be paid off whenever the house is sold (it's a "material change" and you can't use the equity of a home you don't own anymore as collateral). Mortgages, home equity loans, and home equity lines of credit are rarely carried to the 10-, 15-, 30- or 40-year term on the contracts, as most homeowners sell their houses or refinance their debt every five years or so. As long as the payments for the 15-year term could fit in her budget, I said, she should take that option; the interest rate was lower and that's all that really matters in the medium-term outlook.

Then she explained the unusual terms of this credit union's loans; the payment was calculated, not based on the term and interest rate, but based on the size of the loan. For $100,000, the payments were $1,200 a month no matter what. I did the math; on the 6.75% loan, the payoff amount would be more than $2,000 less than the 7.00% loan. Easy decision, and it's my mantra: always pick the lowest interest rate.

There's on caveat, of course, and that's origination fees and other costs associated with signing the loan. In this scenario, the 15-year and 30-year loans had similar fees. But if you were to compare loans from different institutions, you'd want to add fees into your equation. If the 7.00% loan, for instance, had $2,500 less in origination fees (which would be unusual for a home equity loan like this), I would have advised my friend select that option.
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