Shopping for a mortgage means that you will have to make many decisions, including the term. If you are like the standard borrower, you’ll opt for the 30-year fixed term. But that’s not your only option. You may be able to take out a 10, 15, 20, or 25-year term.
Are the shorter terms better though? We’ll discuss the pros and cons of a shorter-term mortgage below.
The Advantages of a Shorter Term Mortgage
Let’s say you can afford the 15-year mortgage term. Does it make sense to do so? Following are the benefits you may realize.
- Lower interest rate – The less time you take to pay back your mortgage, the lower the interest rate a lender may charge you. This is because they have the advantage of lending the money to another borrower much sooner with a 15-year term versus a 30-year term. As you increase the term to 20 or 25 years, your rate may increase slightly, but it’s usually still lower than the 30-year term.
- Less interest paid – If you were to keep the loan for its entire term, you’ll pay approximately half of the amount of interest on a 15-year term than you would a 30-year term. This is often a detail borrowers overlook. They tend to focus on the monthly mortgage payment rather than the total savings over the life of the loan.
- Build equity quicker – Because your payments are comprised of a lot more principal with a shorter-term loan, you build equity in your home much faster. While it’s not considered liquid, you can get access to the funds by refinancing with a cash-out loan.
The Disadvantages of a Shorter Term Mortgage
You should know about the downsides of shorter-term mortgages as well.
- Higher payment – Because you have less time to pay the loan back, you’ll have a higher monthly mortgage payment. The upside to this negative is a larger portion of your payment will be principal, rather than just interest. But, you have to make sure that you can afford the higher payment in the first place.
- Saving is harder – With a higher mortgage payment, it may be harder to keep funding your emergency fund or retirement savings. If your mortgage payment takes away from your ability to pay, it could diminish the benefits of taking the shorter-term.
Which Term is Right?
So how do you decide between the 15-year term and the 30-year term? You have to do a little evaluation of your financial position. Consider the following:
- How soon will you retire? If it’s within the 15-year range, a 15-year loan may be something you want to consider unless you don’t mind having mortgage debt while retired.
- How much can you afford? If you are settled on the price of your house, your next decision is how much of a mortgage payment can you afford? Can you afford the 15-year payment without struggling? If not, the 30-year term might be better.
- How much will you save? Saving is important. If you are going to overextend yourself with the 15-year payment and have to neglect your savings, it may not be worth taking the shorter term.
- Is your income fluctuating? If you work on commission or are self-employed, you may want to consider the longer term just for safety. If you find that you have the extra money to pay the loan down faster, you can. But if you reach a point where making even the 30-year payment is a struggle, you can just make the 30-year payment for the time being.
As you can see, there are pros and cons for both the 15-year term and the 30-year term. Figure out which one works best for your situation and go from there. You can always make extra payments towards your loan if you think you can afford it. You can’t, however, make a smaller payment than the minimum 15-year payment if you chose the 15-year term.