Should You Go For a 30 Year Or 15 Year Mortgage Term

Once you have decided on the kind of mortgage you want such as fixed rate, adjustable rate or a hybrid loan, the next decision that you are likely to face these the duration of the loan. Should you choose a 30 year mortgage with a lower payment or a 15 year mortgage that will allow you to pay off your mortgage quicker.

The main advantage of a 30 year mortgage is that the monthly payments are going to be less. This may even allow you to qualify for a larger sum of money as your monthly payment means that you have your debt to income ratio.

However, you will have to take your monthly payments with a pinch of salt because over the entire term of the mortgage you will pay double the money as interest as compared to a 15 year mortgage. A 30 year mortgage will allow you to have more free cash on you if that is an important criteria.

So while you may pay more money as interest over the long run, you will be able to fulfills your other financial goals at the same time such as saving for retirement, vacation, children’s education sector. A mortgage loan payment should always be enough so that you don’t feel financially stable. A fixed-rate 30 year mortgage can typically have a payment that is 25% lower than a comparable 15 year mortgage.

Saving mortgage on a monthly basis will also allow you to make more productive use for it money on our 30 years. This productive use includes putting money away for retirement which will not only accrue interest on a compounded basis but is also tax deductible and tax deferred for future. You can make contributions that add to your employer-based 401K as well as self-employed SEP–IRA or Keogh’s. Everyone with employment income can contribute to an individual retirement account, IRA although these contributions may not immediately be tax-deductible if you or your spouse’s employer offers a retirement account or pension plan.

As long as there are no pre-payment penalty on a 30 year mortgage, you can make extra payments and finished paying off your mortgage much sooner. Just making one extra payment annually can reduce the term of the mortgage by as much as 7 years. Any more payments made towards the principal amount can allow you to pay off the mortgage in 15 years without having had to be constrained with higher monthly payment of a 15 year mortgage. However, this will require discipline and savings on your part.

A 15 year mortgage is a good idea if you have enough money to meet the monthly mortgage payment and you are reasonably sure that you will not be financially constrained in any way. If you can afford a 15 year mortgage and you can save a lot of money in interest. However, for most of the people 30 year mortgage tends to make more sense.

You should always endeavor to pay off your mortgage as quickly as possible. Even with the 30 year mortgage always ensure that there is no prepayment penalty. This way you can make extra payment towards the principal amount and pay off the mortgage loan quicker.

Long-Term and Short-Term Mortgages

Any mortgage loan that is taken for the duration more than 30 years is considered to be a long-term mortgage. Conversely any mortgage that has a term for less than 30 years is considered to be a short-term mortgage.

A few years back 30 year mortgages were the most common kind of mortgages that could be found.. Short-term mortgages were not really in vogue. However, you could find short-term mortgages with a balloon payment clause included in them. This means that you paid the fixed monthly amount the same as the 30 year mortgage but at the end of a fixed period such as 10, 15 or 20 years you were expected to make a large payment, also known as a balloon payment, to pay off your mortgage obligation completely.

It goes without saying that the total interest charges on a short-term market is far less as compared to a long-term mortgage. While it is common to find a lower rate of interest on a short-term mortgage, even if the interest rate on both the mortgage is same, a short-term mortgage of 15 years is preferable to a 30 year mortgage. Since you are endeavoring to pay off the mortgage in 15 years the payment is going to be higher as compared to long-term mortgage. However, you can save almost half the amount of money on interest as compared to 30 year mortgage. Generally speaking the 15 year fixed-rate mortgage is about half percent point lower than a 30 year FRM.

Another point to note is that while you may be making higher monthly payments on a short-term mortgage for 15 years, it is precisely for that reason that it may be more difficult to qualify. Because a higher monthly payment will increase your debt to income ratio, it might go beyond the acceptable limits of the lender which is usually that your debt should not exceed 45% of your gross monthly income. Another thing to consider when taking a short-term mortgage is that you should not feel tied up for cash due to the higher monthly payment. You should not be in a position where you feel that your cash reserves are getting so depleted so as to not have a safe financial cushion to account for emergencies. If you are unsure about how much mortgage you can afford, we suggest you go back to the section to see how much mortgage you can really afford.

What is Principal, Interest, Term and Amortization

While these factors are basic to a mortgage loan, it is equally true that the principal amount, interest rate, term and modernization is common to all kind of loans. It does not matter what you are buying from the money that you borrow, these terms will apply and will hold you in good stead if you understand them. Let us speak about them one by one.

Principal

The principal of the loan is the amount that you have originally borrowed. If you borrowed $200,000 to purchase a home, then $200,000 is the principal amount.

Interest

Interest is what the mortgage lender or any other kind of credit lender earns on the principal amount that you borrow. Taking the previous example of a mortgage of $200,000 from a lender, the lender will charge a certain rate of interest on this amount. This is what he will earn on the money he has lent you. The interest rate on different loans differ. While a mortgage loan usually has the lowest of interest other kind of loans such as credit cards may have interest rate as high as 24%.

Consumer interest for outstanding balances such as credit card debt and a car loan is not deductible on your federal income. Interest paid on a home loan can be used as deductions from your state and federal income tax. This is one of the many advantages of taking a mortgage loan.

Term

The ‘Term’ of the loan is the duration in which you are supposed to pay back the principal plus interest to the lender. This is the time given to you by the creditor to repay the money that you have borrowed. Smaller loans usually have a smaller term whereas larger loans have a longer term. You typically get more time to pay back larger loans in order to keep the monthly payments low. For example you would spend $734 a month to repay $100,000 loan with an 8 percent interest rate on the 30 year mortgage term. The same mortgage would cost you $956 a month with a 15 year term. Even though the 15 year loans payment is $222 higher you’d pay far less interest on it over the life of the loan.

At 8% you are paying $72,080 in interest over 15 years whereas for 30 years you’ll be paying $164,240 as interest. Don’t get fooled by a low monthly payment for long-term mortgage. It will be more costly in the long run as compared to a mortgage with a shorter term. The reason why people choose a longer term over a shorter term is to reduce the monthly payments and to make it the size that they can afford to pay comfortably every month. Apart from that, the quicker that you can pay off the loan the more money you save.

Amortization

The fully amortized monthly payment means that if all other factors remain same such as the interest rate and the term, your loan will be fully repaid by the time you’ve made your final loan payment according to the term of the mortgage.

Typically speaking, each monthly mortgage payment that you make fully amortizes what you owe on the loan. Amortization means making periodic installment payments on a loan amount which consist of principal and interest.

Usually the amortization schedule of your mortgage or any other kind of loan is worked out in such a way by the lender that during the initial years of the loan, the installment payment goes mostly towards paying off the interest and very little towards reducing the principal balance owed on the loan. This ratio decreases with time. So in other words, the lender makes sure that he takes his profit on the loan from you as quickly as possible.

What Is The Most Common Term For A Home Loan

The commonest mortgage term periods in the US are a 15 year mortgage or a 30 year mortgage.

Regardless, of what duration you choose, you usually always have the option of paying off the home loan faster by making extra payment, lump sum payments or prepaying the loan.

There are two parties involved in deciding on what the duration of a mortgage loan should be, the consumer and the lender.

The consumer decides on the duration of the mortgage loan based on how much money he requires to purchase the home and the amounts that he can pay comfortably as monthly instalments.  Getting a mortgage for a shorter duration may mean a higher monthly installment but it means that you save money in the long run on the interest. Getting a longer tenure for a mortgage may be a necessity if you cannot afford high installments every month and prefer to pay a little extra money in the long run.

The lender also has a say in the duration of the mortgage loan. For example lender may be willing to give you a mortgage for 15 years but not for 25 years. The lender may feel that you will be in a better position to make the monthly payments earlier on in your life than later. 

A long tenure may also be not agreeable to the lender if he calculates that the mortgage is going to last beyond the consumer’s retirement age. They may resort to the traditional outlook that a person retiring at 60 or 65 may not be able to afford the mortgage on the basis of the pension that he receives.

However, if you have your own strong reasons for choosing a particular tenure for a mortgage and you find that the lender is not willing to extend the same to you feel free to shop around as there is plenty of competition in the market. Different lenders have different underwriting rules and guidelines were giving out mortgage.