What Mortgage Term is Best?

August 23, 2011 2 Comments »

terms

Mortgage Q&A: “What mortgage term is best?”

Before you set out to snag the lowest rate on your purchase mortgage or refinance, you’ll need to decide on (or at least narrow down) a mortgage term.

By “mortgage term,” I mean the length of your mortgage. Why does it matter? Well, your mortgage payments and the amount of interest you pay will be determined, in part, by the term of your mortgage.

For example, a 15-year mortgage is paid off in half the time of a 30-year mortgage, so the monthly mortgage payment will be much higher.

It won’t be double the amount of the 30-year, because you’ll pay less interest over the shorter period of time, but it’ll be significantly higher.

This can obviously stretch a budget thin, so it’s important to decide on term before shopping to ensure you wind up with the right loan program to fit your unique financial profile.

The 30-Year Standard

Most mortgages are based on a 30-year amortization, meaning they are paid off in full after 30 years.

At the same time, not all 30-year mortgages are fixed for 30-years. That’s right, there are a ton of mortgages based on a 30-year payoff schedule that can adjust monthly or annually.

A common example would be the 5/1 adjustable-rate mortgage, which is amortized over 30 years, but adjustable after just five.

It’s fixed for the first five years, and adjustable for the remaining 25, but still a 30-year term loan.

Same goes for a 7/1 or a 10/1 ARM, except their fixed period is seven or 10 years, respectively, before going adjustable.

15-Year Mortgages

Then there are 15-year mortgages, which are amortized and paid off in 15 years. They are fixed for the entire duration, so you don’t have to worry about your mortgage rate adjusting higher (or lower, not that you’d worry about that).

These are a great choice if you want to pay off your mortgage early, assuming your money isn’t better served elsewhere.

With a 15-year mortgage, you’ll enjoy a lower mortgage rate than a 30-year loan, and pay much less interest. A win-win really.

Let’s look at an example, assuming the loan amount is $200,000.

30-year payment: $998.57 (4.375% rate)
Total interest paid: $159,485.20

15-year payment: $1,429.77 (3.50% rate)
Total interest paid: $57,358.60

So the 15-year mortgage would save you roughly $100,000 in interest over the full term, but your monthly mortgage payment would be about 50 percent higher.

If you could handle it, and actually want to pay down your mortgage, it’d be a worthwhile move, especially if you were refinancing from a higher rate.

If you rate was at, say, 6.5 percent on a 30-year term, refinancing to a rate of 3.5 percent on a 15-year term today would only be an additional $200 a month.

(30-year fixed vs. 15-year fixed)

What Other Mortgage Terms Are Available?

Mortgage terms don’t stop at 30 and 15. There are plenty of other options, including 10 year, 20 year, 25 year, 40 year, and even five-year terms.

Yep, you can pay your mortgage off in just 10 years or stretch it out to 40 years if you need a little more time.

If 15 years is too quick, but 30 is too long, there’s always the 20-year mortgage.

There are even mortgages amortized over 40 years that are due in 30, so the options are endless really.

The last one on the list above refers to the ING Easy Orange Mortgage, which is due in full after just five years. Of course, they’re setup so borrowers refinance/sell at that time, and they’re amortized over 30-years, making them balloon mortgages.

Average Mortgage Term

Keep in mind that most people only hold onto their mortgages for about seven years.  This is a result of either selling the home and moving on, or refinancing the existing mortgage to take advantage of lower mortgage rates, or to get cash out.

So whatever mortgage term you choose, be sure it makes sense for your particular situation, and also from both a mortgage rate and monthly payment perspective.

Don’t pick a 20-year over a 30-year term if the rate isn’t significantly better.

And don’t go after a 15-year term if you think you’ll have a tough time making the larger payments, or if you think you may move in just a few years.

To summarize, the longer the term, the lower the mortgage payment, but the more interest you’ll pay and longer it will take to build home equity.

Tip: If you aren’t sure what term to pick, you can always make larger payments on a longer-term loan (biweekly mortgage payments).

If you go with a shorter term, you’re stuck with a large payment no matter what.  So if you want to err on the side of caution, go with the standard 30-year term and make extra principal payments when and if you can.

2 Comments

  1. Jacquelyn July 20, 2013 at 8:10 am -

    I think it depends. If you can afford it, a 15-year term will save you a lot of money on interest, and you will own your home a lot quicker. But a 30-year fixed loan term is also a solid choice if you want to keep payments down and pay off your home in a reasonable amount of time. I wouldn’t go above a 30-year term though…40-year terms and longer are bad news.

  2. Aminah August 19, 2013 at 4:46 am -

    With rates as low as they are, why not drag it out a bit. I’m not saying a 40-year loan makes sense, but a 30-year set at 4% and change is a good deal. And once inflation erodes the dollar, those fixed monthly payments will be ultra-cheap later in the term.

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