Not all home loans are the same and finding the best deal can take some work. Shopping around for the best and most competitive loan might seem complicated due to the different loan terms, interest rates, and monthly payments.
Your mortgage term is how long you get to pay back the money, and choosing the term is one of the most important financial decisions you’ll ever make. Your term affects your rate, monthly payment, and total costs of borrowing. Let’s review the details of home loan terms work!
WHAT IS A MORTGAGE TERM?
When you take out a home loan, the mortgage term is the amount of time it takes to pay back the money you’ve borrowed, plus interest. At Fibre Federal Credit Union, we offer several options: 10, 15, 20, and 30-year terms. Keep in mind that 10-year terms are generally for a home loan refinance, not a purchase.
Each term is the maximum amount of time you have to pay off your loan in full, but you can also make extra payments to pay your loan off early. Choosing the term length best for you might seem difficult at first, especially if you’re a first-time homebuyer.
Your decision impacts your financial situation in both the short and long term, so you need to pick a term that meets your current financial needs as well as what you anticipate in the future.
Impact of Term on Interest/APR
Your annual percentage rate (APR) includes the interest rate, fees, and any mortgage points, so it’s better to compare APRs than just rates when choosing a home loan.
Shorter loan terms of 10 or 15 years get a lower APR because they’re considered less risky. This means you pay less interest per month and less total interest over the life of your loan. Longer loan terms of 20 or 30 years get a higher rate, so your total cost of borrowing goes up even if your monthly payment is lower.
Impact of Term on Monthly Payment
Choosing a longer loan term of 20 to 30 years gives you more time to pay off your loan and a lower monthly payment. This means a monthly mortgage payment will fit into your budget more easily, and you can afford to buy a more expensive home.
A 15-year term means your monthly payments will be higher, but your rate will be lower. If your budget is tight and you want a shorter term, you may need to look at a home with a lower purchase price.
Impact of Term on Total Costs of Borrowing
You want to choose the shortest loan term that gives you a monthly payment you can comfortably afford. A 15-year term means you’ll pay significantly less interest over the lifetime of your home loan compared to a 30-year term. You may find a 20-year term is a sweet spot in the middle!
WHEN TO CHOOSE A SHORT HOME LOAN TERM You need to choose the best loan length for your financial situation. First, let’s consider why you might want to choose a 15-year mortgage.
You Can Afford a Higher Monthly Mortgage Payment
Your monthly principal and interest payments will be much higher if you choose a shorter term for your mortgage. When you qualify for your loan, lenders look at your debts, but not expenses like emergency medical bills, education costs, or vacations.
Choose a 15-year term if you have a roomy budget and can still afford to cover your current bills and other expenses.
You Want to Build Equity Faster
With a 15-year mortgage, more of your monthly payment is going toward your principal each month, which allows you to build equity in your home at a faster pace. You’ll also own your home free and clear much sooner and can spend those funds elsewhere or put the money toward a savings account.
Longer loan terms mean more of your payment goes toward interest.
You Don’t Plan to Stay in Your Home Long
If you know you’ll have to sell quickly, choosing a 15-year mortgage can help you build more equity and make the most money when reselling. You’ll be paying more principal and less interest, meaning you’ll have more of a profit once all fees and commissions are paid.
Now let’s turn to longer home loan terms of 20 or 30 years. Consider if any of these situations are true for you before deciding which term to choose for your mortgage.
You Want a Lower Monthly Mortgage Payment
Your repayment term is longer with a 20 or 30-year loan, which spreads out your mortgage payments over a longer period, so your monthly payment is lower. This allows more room in your budget from month to month so you can focus on your financial goals and savings.
You Want the Option to Pay Off Your Loan Faster with Extra Payments
Taking out a mortgage with a longer term gives you the flexibility to put extra payments toward your principal whenever you have the additional money to do so. This reduces your total repayment term and makes great use of a work bonus, tax refund, or side income.
You Want to Buy the Most House You Can Afford
You’ll likely qualify for a higher loan amount with a 20 or 30-year mortgage term. This means you can buy a more expensive house based on your family’s needs. Also, this is the better route to go if you know you’ll be in the home for a long amount of time.