30 Years or 15 Years Fixed Rate?
Two of the most common mortgage loan terms are the 30-year mortgage and the 15-year mortgage. First time home buyers typically choose the 30-year mortgage because of its lower monthly payments. The amount of the home loan is spread out in monthly installments to be paid out over the course of 30 years, totaling 360 installments, while the 15-year mortgage is paid in monthly installments over the course of 15 years, totaling 180 installments. For instance, the mortgage payment on a $100,000 house with a 7.5% interest rate is only $699 per month. Compare this amount to the $913 monthly payment from a 15-year mortgage with a 7.25% interest rate. The lower monthly payments of the 30-year mortgage allow buyers to save more of their money at the present time.
However, after ten years, buyers with a 15-year mortgage will have paid about half of their balance while buyers with a 30-year mortgage will have paid less than 15% of the total amount. This is a significant difference in the amount of equity that is acquired. Buyers who want to build equity quickly and can afford the higher monthly payments often opt for the 15-year mortgage loan term. A longer home loan period does offers you more flexibility in that if your financial situation were to take a turn for the worse, for example, you just lost your job and jobless for the past few months. A lower monthly home loan payment helps to alleviate some of the financial problems. The longer or shorter home loan plan? If you have the financial knowledge and your financial situation is stable, it would be a good choice to take the 30-year loan and invest the savings otherwise pay towards the monthly payments.
The long term payoff of your investment may match or exceeds the money you go towards repaying your home loan. On the other hand, if you do not have the financial stability and knowledge, a shorter home loan is better for you. Yes, you do pay more each month but overall you will pay less for the home loan plan. Also you get to accrue equity in your home much faster which can be used to improve your credit score or FICO.
Do 40-Year Loans Make Sense?
The 40-year fixed loan allows you to amortize the loan over a 40-year period instead of the usual 30 years. This results in a lower monthly payment, which can come in handy when rates are higher.
There are some pros and cons to this type of mortgage. I will explain why I personally don't like these loans except in special circumstances. The main advantage of a 40-year fixed loan is that your monthly payments are lower. Since this loan is typically fully amortized (a small amount of principle is paid down monthly), the loan balance will slowly decrease each month. This is the main advantage of a 40-year fixed loan over an interest-only loan if your goal is to pay down principle. Another advantage is that while most interest-only loans have minimum FICO requirements of approximately 580, a 40-year fixed loan is available if your FICO score is as low as 500.
However, there is more to consider in choosing the length of a mortgage term than the monthly payments alone. The longer the term is on a mortgage, the more a homeowner can expect to repay in interest over the life of the loan. Even with a great interest rate, this amount can be significant. Let's consider the same example of the $200,000 mortgage at 5% interest. If a homeowner were to borrow this amount over 15 years, he would repay approximately $84,685 in interest alone over the life of the loan. This same amount, if borrowed for 30 years, would cost the homeowner $186,513 in interest by the time the loan is repaid. Since a 40-year mortgage is longer than either of these options, it will obviously require repayment of the most interest.
In fact, over 40 years, the homeowner can expect to pay $262,913 in interest alone. That is more than the original amount of the loan. Borrowing the money for 40 years will cost the homeowner $178,228 more than if he had chosen the 15-year mortgage, and $76,400 more than if he had chosen a 30-year mortgage. A careful look to compare the 30 and 40-year mortgages will show that the monthly savings is only a little more than $100, while the difference in the amount of interest that will be repaid is significant. A 40-year mortgage is a good deal for people in highest housing markets such as the Northeast or on the West Coast, where the average growth in property value is surpassing the average growth in income. It can help keep your payments low much like an interest only loan, but with the stability of a fixed interest rate and monthly payment. These longer term mortgages are very beneficial for people who don't plan on moving any time soon. The bottom line is that 40-year mortgage loans can be useful for keeping your payments low, but longer-term loans are not for everyone.
How to Select a Mortgage Term?
While the most popular terms are still 15- or 30-years, you can find a range of variations, including 10-, 20-, 25-, or even 40-year home loans.
In order to find the perfect match, ask yourself the following questions:
- How long do I plan to stay in the house?
- How much money can I afford to pay for my mortgage each month and still have enough to save for retirement and other important financial matters?
- How does the pay-off date fit in with my financial goals and dreams?
It is important to consider what suits you best rather than rushing into a shorter mortgage term simply to try and get out of debt more quickly. If you are able to make higher mortgage payments without struggling financially, then you could benefit from a shorter mortgage term as this will cut the amount you pay in interest over the long term. However, if there is any doubt about whether you can afford the higher monthly payments you are far better off opting for a longer mortgage term and enjoying the peace of mind that you will be able to meet the payments and cope with any fluctuations in the case of an adjustable rate mortgage. It's okay to stretch out your mortgage term if you can't afford large monthly payments, but stretching it out more than 15 years will probably be more of a hindrance than a help, no matter how low your interest rates are.
Keep in mind as well that a long mortgage term means it will take much longer to build equity in your home, and that a longer term loan will most likely have a higher interest rate, since the bank has more of a chance of you walking away before the loan is paid. The simple answer is that you should make your mortgage term as short as possible. The larger the monthly payment you can afford, the shorter your term will be, and you'll receive better interest rates and equity in your home that much sooner. Also, with a short-term mortgage, the house will be yours to own that much quicker.