How Mortgage Term Affects Home Buyers
When potential home buyers begin to research mortgages for buying a home, they are confronted with a lot of different and possibly confusing words or contract terms. One of those terms is the length of the mortgage. The length of the loan is an important decision to make. Although there are mortgages with a variety of term lengths, 15 and 30 years are the most common. Home buyers should understand the differences between these loans, how they can affect the monthly payment and the way the loan is paid off. This comparison will help buyers make a more informed decision about their mortgage options.
The biggest difference between a 15-year mortgage and a 30-year loan (other than the number of years of the loan) is the monthly payment. With a loan duration of 15 years, homeowners pay off the loan in half the time of a 30-year version. In order to achieve this, the monthly payment is typically considerably larger. In fact, people can expect the monthly payment to rise by about 50 percent for 15 years compared to 30. Property taxes and homeowners insurance are calculated independent of the type of loan, so they should be similar for either. As such, the vast majority of the payment difference between these mortgages is principal.
Mortgage Interest Rates and Loan Options
Although a 15-year fixed-rate mortgage is structured similarly to a 30-year loan, there are a few fundamental differences. As a general rule, loans set for 15 years tend to carry lower interest rates than 30 years. Lenders set interest rates based on the risk they take on for the loan as well as the borrower. Shorter loans create less risk because they do not last as long. Mortgages for 15 years can have interest rates between 0.25-1 percent lower than a 30-year mortgage. Buyers who can qualify for a higher monthly payment could save a significant amount of money on interest with a shorter loan. Not only would they pay it off sooner, but they would also pay less interest on the principal every month.
Home buyers should keep in mind that 15-year mortgages are almost always fixed-rate. With a 30-year loan, people may be able to choose between fixed-rate and adjustable-rate options. Many borrowers prefer a mortgage with a fixed rate because it provides a predictable payment for the duration of the loan. However, buyers who want to consider other loan types are often limited to 30-year mortgages.
Total Interest Paid
Although an annual percentage rate (APR) for a mortgage is set by the year, the interest is usually accrued and paid on a monthly basis. As the principal owed goes down, the total interest paid also decreases. With a 30-year mortgage, homeowners often pay very little toward the principal in the first couple of years. This is because interest takes up so much of the monthly payment. Since a 15-year loan sets aside a much larger portion each month toward paying off the principal, the interest bill decreases more quickly. This means that a 15-year loan would require a much lower amount of total interest paid, even if it had the same interest rate as a 30-year mortgage.
Home Buying Power
Although many people would like to consider both types of mortgages, not everyone gets the opportunity. Most buyers are constrained by the amount of money they can qualify for in a loan. The monthly payment lenders will consider for an applicant typically does not exceed 28-33 percent of the buyers' gross monthly income. Some buyers are also limited by other debts they have. A monthly payment that is 50 percent higher may translate into a lower total amount that buyers can receive. As such, many people who want a 15-year loan may need to buy a less-expensive property. Those who have limited income or who live in a region with higher housing costs may not be able to qualify for a 15-year loan at all.
Making a Choice
Ultimately, people who have the ability to choose between a 15-year mortgage and a 30-year loan should look at their goals and see how each duration fits. Buyers who have a lot of extra income to devote to principal may appreciate seeing their equity rise more quickly. People who may need to move within a few years might also want a 15-year loan, so they can sell the home at a higher profit. By comparison, buyers who want to stay in the home for a long time may not need to pay down the loan so quickly. The flexibility of a lower payment may make it easier for people to handle fluctuations in their income and expenses over time.
For many Tournament Hills home buyers, the process begins by determining what they can reasonably afford. Considering 15-year and 30-year mortgages can help them decide how they want to plan for paying off the loan by selecting a monthly payment that works best for them.