Selecting Mortgage Term
When selecting a fixed-rate mortgage, you know your interest
rate will remain constant throughout the life of your loan.
However, how long the loan goes on is up to you. The mortgage’s
term is technically the period of time used to calculate the
monthly payments. This is different from the maturity, which
is the period of time until the final payment on the mortgage
is due. For most loans they are the same and term is used
to denote both – however, on balloon mortgages where
a lump sum is required at the end, the two numbers are different.
Longer terms lead to smaller monthly payments, but slow down
the borrower’s ability to build equity. Buyers who want
to make the smallest possible payments will want to select
longer terms. The most common terms are 30 years, 20 years,
and 15 years, though other terms such as 40 years and 10 years
are available. As terms get longer and longer, the monthly
savings get less dramatic. For example, extending a $100,000
loan at six percent from a ten year term to a twenty year
term saves $394 in monthly payments. Extending the term of
the same loan from twenty years to thirty years saves only
$116, and a further extension from thirty to forty years saves
only $50.
The savings in monthly payments is also less pronounced at
higher interest rates. For example, the $100,000 loan at six
percent saved $116 by extending from twenty years to thirty
years. At twelve percent, the same extension would save only
$72.
However, if you are more interested in building equity quickly
than paying lower monthly payments, shorter term loans are
very effective. Again consider the borrower with a $100,000
loan, this time at seven percent. If this borrower chose a
15-year term, he will have repaid almost 55 percent of the
principle after ten years. If the borrower chose a 30-year
term, he will have repaid slightly less than 15 percent of
the principle in this same time period.
In the end, considerations about whether you wish to build
equity or save money on monthly payments will drive your decision
on the term of your fixed-rate mortgage.
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