You’re in the market for a mortgage. One of the most critical decisions you need to make is the length of the mortgage. While 30-year mortgages are the most popular option, it may not be the right option for you. How can you tell?
Let’s look at what you should consider when determining the length of your first mortgage term.
The Available Options
The most common mortgage terms available are 15-year and 30-year. However, lenders offer other options for interested borrowers. You might want a 10-year, 20-year, or even a 40-year loan period.
Here are some rules to remember when it comes to loan terms:
- Shorter loans have higher monthly payments, while longer loans have a lower one.
- Shorter loans have lower interest rates, while longer loans have a higher one.
- The borrower pays less interest on a shorter loan and more on a longer loan.
Mortgage Interest Rates and Monthly Payments
A 15-year mortgage loan will have a lower interest rate than a 30-year loan. The interest rate is calculated as the amount of risk a bank is willing to take on the loan. If the length of the mortgage term is shorter, the bank is assuming less risk, which is reflected in the lower interest rate.
Longer mortgages mean a higher amount of risk to the bank. A 30-year term is twice as long as a 15-year term. That’s twice the amount of time for the borrower to have problems repaying the loan.
While shorter loans have lower interest rates, they also have higher monthly payments. A longer loan has smaller payments. Many borrowers leverage a longer loan term to buy a more expensive house. Instead of paying $1500 on a 15-year loan for a less expensive home, they can make a similar payment amount on a 30-year loan for a more expensive one.
Let’s Run Some Numbers
The easiest way to understand what all of this means is to compare different lengths of mortgages. Then, look at the interest rates, monthly payments, and interest paid over the life of the loan.
Let’s take a mortgage loan for $250,000 and see the differences between a 15-year at 3% and a 30-year term at 4%.
The 15-year mortgage loan would have a monthly payment of $1,726. The borrower would pay a total of $310,761, with $60,781 being the interest paid. In contrast, the 30-year mortgage loan would have a monthly payment of $1,194. The borrower would pay a total of $429,674, with $179,674 being the interest paid.
The 15-year loan’s monthly payment amount is $532 more than the monthly payment on the 30-year loan. That’s a significant amount for many families. A lower monthly payment might be more attractive for those with a lower income.
With the longer loan, the borrower is going to pay $118,913 more in interest over the life of the loan compared with the shorter loan. The interest on the 15-year loan is approximately 1/3 the amount of interest being paid on the 30-year loan.
What Should You Consider When Selecting the Length of a Loan?
Interest rate and monthly payment amount are two major considerations when it comes to selecting your mortgage term. However, they aren’t the only things to think about.
How long are you planning on staying in your home? If you are only planning on being there for a few years, a shorter-term loan would allow you to pay the mortgage off quicker and to build equity faster. If you plan on staying at least 10 to 15 years, a longer mortgage term gives you lower payments.
Do you have a major life event coming up? If you plan to retire in a few years, it’s wise to pay off your mortgage first. That way you can comfortably retire with a lower income and not worry about a monthly mortgage payment. If you have kids going to college soon, a lower monthly payment might be a better choice because it frees up money to put towards their tuition and books.
Do you want some flexibility in your payment options? A 30-year loan gives you the option of making the lower payment every month and making higher payments when you can. Making higher payments pays the home off faster with less interest, with the ability to go back to the set payment if finances get tight.
Before you grab the first loan offered, it’s important to talk with professional mortgage lenders in DC. Call the Busch Team at First Savings Mortgage today. We want to help you find the perfect loan for your new home.