What You Need To Know When Choosing A Mortgage Term Length: 15 To 30 Years?

Purchasing a home is likely the largest purchase you will make in your life time – and there are many decisions that have to be made when you’re ready to take the plunge into home ownership. Of course primarily, you have to choose a house, but more than that, you have to choose a mortgage. There are many different mortgage types to choose from, and choosing the right one is essential to your long-term financial success.

The most basic mortgage types are fixed rate and adjustable rate mortgages. Adjustable rate mortgages, commonly known as ARMs, are mortgages that have a fluctuating interest rate that changes at various periods in the mortgage. A fixed rate mortgage has a stable rate – one that is set at the beginning of the mortgage and stays the same throughout. Many new homeowners choose a fixed rate mortgage for the stability of interest rates and payment amounts, and fixed rate mortgages are the best choice if you can lock in a low interest rate.

When you make the decision on the house that you want and that you want a fixed rate mortgage, the next step is to choose the length of mortgage that you want – either a 15 year or a 30 year (although there are longer mortgages, up to 50 years).

While it seems that the decision between 15 and 30 years should be an easy one, there are many variables to consider. There are many different viewpoints in this arena, and you should choose the one that fits your situation best.

Choosing the shortest mortgage you can afford

With a shorter mortgage term, your payments are higher, however the advantages are that you pay less interest on the house and own the home faster. Thusly, you also build up equity faster and if you are considering borrowing against that equity for something in the future, such as college education, then paying off the mortgage faster is the best way to go. The general consensus amongst home owners is to get the shortest mortgage you can afford so that you pay less for the house (in interest payments to the bank) and own the home faster. After all, you can always refinance later or borrow money against the equity.

Get a longer mortgage with more affordable payments

There are some financial advisors that will tell you to get the longest mortgage you can afford – basically a mortgage is an inexpensive long term loan. You can reinvest the money you’re saving monthly into stocks and make money on them, but that’s only if you dabble there. For many people, they look for a longer mortgage for the affordability of the monthly payments. For many families, this means being able to afford a bigger, more expensive house because the payments are trenched out over 30 years. The same large, expensive house in a 15 year mortgage means the family can no longer afford the payments. The choice for many is the difference in square footage, area, neighborhood and city placement. If you’ve got your heart set on that larger house in the subdivision because it’s what works for your family, then a 30 year mortgage is where you’ll likely end up.

Taking a longer mortgage to allow for payment flexibility

If you don’t have a mortgage prepayment penalty on your mortgage (and you should try not to have one), you don’t have to take 30 years to pay off your mortgage. In this sense, the 30 year mortgage sets a minimum payment for you. Without prepayment penalties, you can send extra money to your mortgage, which is applied directly to the principal, and pay off your mortgage in less time.

Many people choose a 30 year mortgage for this reason – it means they can pay the mortgage off in 15 years if they apply the extra money to the mortgage, but that they aren’t stuck making the larger monthly payments that are associated with a 15 year mortgage. A 30 year mortgage can be safety net instead – in case there is a financial set back, illness, unemployment, etc, that means you wouldn’t be able to make more than the ‘minimum payment’ of your 30 year mortgage loan payment for a few months (or years). Failing to make mortgage payments will mean potential repossession of your home (losing your home) by the bank. This safety net is why most people today choose the 30 year loan.

Higher interest rates with longer mortgages

While it is true that your interest rate will be slightly higher (.25 to 1 full percentage point), the true numbers don’t make that much of a difference. If you figure that you can indeed afford a 15 year mortgage, take a look at these numbers.

A 15 year mortgage interest rate is 5.125 per cent. A 30 year mortgage is slightly higher at 5.625 per cent (.5 per cent difference).

If the monthly payments on a 15 year mortgage are $2,757 and the 30 year mortgage payments are $2,087, the difference in monthly payments is $670. If you take the 30 year mortgage and pay the $670 more each month (providing you have no prepayment penalties on your mortgage) you can still pay off your mortgage in less than 16 years. In fact, what you’ve done is stretched the 15 year mortgage to 16 years, and allowed yourself 14 years of comfort room. The extra money you’ve paid is really just payment for ‘insurance’ against financial hardships for months where you can’t afford to pay the extra $670.

The final decision

The final decision for most families and home owners is to go with the 30 year mortgage for the simple ‘insurance’ factor. This is a great draw to the longer term mortgage – no one can see in to the future, and that great job you have today could be downsized tomorrow. Likewise, you could increase you income substantially and not have to worry (which is really the reason why you need to ensure you don’t have any mortgage prepayment penalties to pay).

Of course, there are families that can more than afford the 15 year mortgage – if that’s the case, then go for it and make extra payments to reduce your mortgage term even more.