One of the first choices to be made when mortgage shopping is what mortgage term will best suit your needs. After all, your mortgage payments and the amount of interest you pay will depend, in large part, on the length of the term you choose. The question is, how long will it take to fully pay off your loan?
How mortgage terms work
Quick truth: the quicker your mortgage is paid off, the higher your monthly payment will be, but the lower your interest paid. The other thing to keep in mind is the question of fixed versus adjustable rate mortgages (ARMs): simply put, fixed-rate loans (the most popular option) offer a set interest rate for the duration of your loan, while ARMs have a fixed rate for up to 10 years, after which they fluctuate with market conditions. The latter might save you money, but can be a bit riskier depending on the state of the market.
The 30 versus 15-year mortgage
Most mortgages are based on 30-year terms, be they fixed or adjustable, and 15-year terms are next on the list. Those paying off their mortgages in 15 rather than 30 years can expect their monthly payments to be about 1.5X higher, while the interest rate runs about 0.75% lower. Why? Because lenders are willing to incentivize faster mortgage payoffs.
On a fixed loan of $200,000 then, where you’re paying $998.57 monthly toward a 30-year mortgage at a rate of 4.375%, your total interest paid would be $159,485.20. Switch to a 15-year term and you get monthly payments of $1429.77 at a rate of 3.50%, for total interest of just $57,358.60! Obviously, the shorter 15-year term is an excellent choice if you want to pay off your mortgage faster and can afford to do it.
Other possible mortgage terms
Not everyone goes for 30 or 15-year terms. Other options include 10, 20, 25, 40, and even five-year balloon mortgages, though not all lenders offer all of these. For homeowners not planning to sell or refinance in just a few years, the shortest mortgage term involving full payment of the loan is typically the 10-year-fixed mortgage, although the high payments it entails make it inaccessible to many.
Ultimately, most homeowners go with a 30-year fixed mortgage. This may not be the best option, however, if you plan to move well before the loan is repaid, because your interest will be high and you won’t be around long enough to benefit from the fixed rate. That said, never opt for a 15-year term if you’re unsure you can manage the larger payments. While a 20 or 25-year term may appear to offer that perfect middle ground, always be sure the rate is actually low enough to make this route worthwhile. Bottom line: whatever you decide, you can always pay extra on your mortgage down the line to save money on interest and shorten your term—talk to your mortgage broker to get a better understanding of all the options available to you!