Applying for a mortgage means you have to make many decisions. Among them is the mortgage term. This determines how long you will take to pay your mortgage back. It has a major impact on the amount of your monthly payment; your interest rate, and the amount of interest you pay over the life of the loan.
Choosing the right term is crucial for financial freedom. Keep reading to learn what factors you should consider when determining the right term for you.
What’s a Mortgage Term?
When you say you’ll take a 30-year term mortgage, you agree to pay the mortgage payment over the next 30 years. Your total loan is then amortized over that 30 years including principal and interest. In the beginning of the term, you’ll pay a majority of interest and less principal. As you near the end of the term, you’ll pay more principal than interest.
If you take a 15-year term, you pay the loan off in half of the time. You’ll also pay less interest because you borrow the money for a shorter amount of time. Generally, lenders offer a lower interest rate for 15-year terms because it’s less risky for the lender to tie their money up for 15 years rather than 30 years.
Looking at the Difference
Deciding between the 15 and 30-year term means you have to look at your budget. Let’s say you found a home for $200,000 and a loan with a 4% rate. All things being equal, the 30-year payment would be $955 and the 15-year would be $1479. That’s a large difference. You can probably quickly determine if you can afford a payment that high. Don’t forget, you’ll have to include taxes and insurance in the payment too, though.
Perhaps the larger difference is the interest you’ll pay over the life of the loan. On the 15-year term, you’d pay $143,700 in interest. On the 15-year you would pay $66,200 in interest. Cutting the loan in half cuts the interest you’ll pay in half as well.
The 15-year term doesn’t work for everyone, though. Now we’ll look at when the 30-year term is ideal.
Choosing the 30-Year Term
The 30-year term looks like it costs more at a glance. The interest alone is probably enough to make you shudder. But, know that you have options. In fact, the 30-year term gives you flexibility and a little stability. You have a lower minimum required monthly payment. This means if you have a rough month or even longer, you only have to make that smaller 30-year payment. Hopefully you won’t feel financially strained and can still make the payment.
The beauty of it, however, is that you can pay more than the minimum payment whenever you want. You can pay an extra $50, $100 or more each month. You can even make 15-year payments if you can afford it. If there are times that you don’t have the money, though, you can just make the 30-year minimum payment. All it takes is one extra mortgage payment per year to knock several years off your loan’s principal.
Choosing the 15-Year Term
If you know beyond a doubt that you have job security and enough money saved to make the higher 15-year payments, it could be worth it. Again, you’ll save quite a bit of money in interest. If you have an unstable job or one where your income fluctuates, option for the longer term is probably the safer option. The 15-year term is for those that know they can afford the higher payment without difficulty.
What are Your Plans?
You’ll also want to consider your future plans. Are you thinking of moving in the next 10 years? You may want to take the shorter loan so you can minimize the interest you pay. As you knock the principal down, you’ll see a greater return on your investment when you sell. You’ll have less mortgage to pay off and more money to put in your pocket.
If you think you’ll live in the home for the duration of the loan, you may want the 30-year loan. This way you have flexibility should anything happen. You won’t risk losing your home because you took payments that were too high.
Choosing the mortgage term is a personal decision. Look closely at your budget and decide what works best for you now. Remember, choosing the 30-year loan gives you other options as you can afford it. Choosing the 15-year term requires you to make those higher payments every month.