Choosing your mortgage loan term is not as difficult as you think.
Many people get very anxious when it comes to choosing the term on their new mortgage, whether it is a home purchase or a refinance. Term is just another way of saying the length of the repayment period on the mortgage, expressed in years. A 30 year fixed mortgage has a 30 year term, so it will be paid off in 30 years if you make the minimum payments. Simple enough. For the purposes of this article, I’ll use the phrases “longer term” and “shorter term” to describe any two loan options in relation to each other. The actual terms you are deciding between don’t matter, the pros and cons will remain the same.
A little known fact:
Here’s something a little more complicated that not many people know. If you choose a longer loan term, but make payments for a shorter term, the loan will behave exactly as if you had chosen the shorter term in the first place. Sounds easy and difficult at the same, but basically you can close your loan as a 30 year fixed mortgage and make 15 year payments and it will pay off in 15 years. To determine payments for a shorter term loan, all you need to do is plug your interest rate, loan balance and the term you desire into any mortgage calculator online and you’ll receive the payment you need to make to pay it off in that time frame.
Why does this matter?
It matters because if you are wrestling with a 30 year fixed versus a 20, 15 or 10 year fixed, you can choose the 30 year fixed and make payments based on what you can afford. If you can afford 15 year payments, you can choose to do so. If your financial situation changes and you need a little extra money each month, you can back off to the minimum 30 year fixed payments.
Why do people choose different loan terms?
You are probably asking yourself at this point why anyone would choose anything but a 30 year fixed mortgage if it gives them so many options. There are positive and negative aspects of each option.
The benefits of shorter term loans:
- Shorter term loans typically have more favorable rates/fees than longer term options
- Shorter term loans force borrowers to put more money toward principal, which some borrowers prefer
- Shorter term loans typically have more favorable mortgage insurance, if required
The benefits of longer term loans:
- Lower payments than shorter term loans
- More flexibility than shorter term loans as far as payment (discussed above)
- Easier to qualify from an income perspective
For most people the choice comes down to more favorable terms for shorter term mortgages vs. lower payments for longer term mortgages.
The reality is that you can choose your loan term, as long as you are making at least the minimum payments. It should be noted that you cannot make payments for a longer term if you are in a shorter term, because your payments would not meet the minimum required payment each month. If you have some doubt as to the monthly payments and whether you can make them, a conservative choice would be to choose a longer term and decide what you will pay. It should also be noted that this only works on loans without prepayment penalties. If your loan has a prepayment penalty, you may still be able to make extra payments, but there may be a cap on how much extra.
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