It’s time for the first mortgage match-up of 2012.
And because paying down the mortgage early seems to be so en vogue these days, let’s take a look at “20-year mortgages vs. 30-year mortgages.”
This relative simplicity and safety explains their popularity, but they aren’t the end all, be all solution for every homeowner out there.
30-Year Mortgages Have Drawbacks
When it comes down it, 30-year mortgages have some drawbacks, with the most obvious one being the long amortization period. They also come with the highest interest rates relative to other loan programs.
And since the mortgage takes so very long to be paid off, more interest is paid. Think of it this way. If you borrowed money from a friend and asked to pay it back over 30 years, they would probably say no.
If by chance they agreed, they’d want to charge you a higher rate of interest. And because you’d be paying it back so slowly, you’d pay a lot more interest over that time.
Assuming your loan amount is large, it could be the difference of many thousands of dollars.
Look to a Shorter-Term Mortgage
So what are homeowners to do? Well, the most common solution to this ”problem” is to look at a shorter-term mortgage.
And while the 15-year fixed is the most common alternative, it comes with its own drawback, namely a much higher monthly mortgage payment.
In other words, not every homeowner can just say, “I want to pay my mortgage off faster” and switch to a 15-year fixed.
Fortunately, there are options in between, with the most common being the 20-year fixed mortgage.
A 20-year mortgage sheds 10 years off the typical loan term, and results in much less interest paid throughout its duration.
Let’s look at an example to illustrate the savings:
Loan amount: $200,000
30-year fixed @4%
Monthly mortgage payment: $954.83
Total interest paid: $143,738.80
20-year fixed @3.75%
Monthly mortgage payment: $1,185.78
Total interest paid: $84,587.20
As you can see, the interest rates aren’t much different, though the 20-year mortgage does price a little bit lower than the 30-year fixed.
Still, the homeowner with the 30-year mortgage pays more than $200 less each month.
But the 20-year mortgage results in interest savings of nearly $60,000! This borrower would also own their home free and clear an entire decade earlier.
This can be pretty beneficial, especially if you plan to retire soon and anticipate being on a fixed income.
The 20-year fixed is also a good alternative because you won’t break the bank making your mortgage payment each month.
But again, the payment will be higher than the 30-year payment, which could stretch you thin or limit what you can afford if you’re buying a home.
Go With a 20-Year Fixed Mortgage to Stay on Course
If you’re currently in a 30-year fixed, and don’t want to reset the mortgage clock, you can refinance to a 20-year fixed to stay on course without even paying more each month.
Because mortgage rates are so low at the moment, you may be able to refinance from a 30-year to a 20-year fixed mortgage and even lower your monthly payment.
Also keep in mind that there are other alternatives outside the 15, 20, and 30-year options.
And some banks even allow you to choose your own mortgage term, whether it’s a 17-year fixed or a 24-year fixed.
So be sure to look at all available options to see which makes the most sense financially for your unique situation.
Also ask yourself why you want to pay the mortgage off early. There may be a better place for your money.
Read more: 30-year fixed vs. 15-year fixed.