When you buy a house for the first time, you will be asked by the lender how long you want the mortgage to last.
In mortgage and real estate circles, this is the term of a mortgage. Most standard mortgages are either 15 or 30 years in length.
However, many mortgage lenders have offered custom loan periods over the last several years. How long you choose to pay the loan will significantly impact the amount of your mortgage payments each month.
What is the term of a mortgage?
A mortgage term refers to the time you will commit to making payments towards your home loan. For example, if you choose a 30-year mortgage, the loan term is 30 years.
A mortgage term is not the same as a mortgage product. A mortgage product would be a type of loan such as an FHA loan. It could also refer to whether it is a fixed or adjustable mortgage.
While a standard mortgage term is often 15 or 30 years, many lenders offer custom loan lengths. For example, you might find a lender willing to do a loan for 25 years.
Some borrowers may want to customize their loan length to a specific point in time.
Maybe you only want to carry a mortgage until you retire. You can ask the lender to amortize the mortgage length based on your planned retirement year.
How mortgage terms work
Besides the length, the most significant difference between a 15 and 30-year mortgage is how payments and interest add up.
With a 15-year loan, you’ll pay significantly less interest to the lender, but your monthly mortgage payments will be much higher.
When you opt for a 30-year loan, the opposite will be true. Due to 15 additional years, you’ll be paying more mortgage interest. The upside for many borrowers trying to purchase a home is their payments will be lower.
Determining which option is best typically boils down to your current financial picture. It makes sense to analyze what you can comfortably afford every month.
Should I opt for a fixed or adjustable rate mortgage
When selecting the length of a mortgage, it is paramount to make an informed decision between an adjustable-rate mortgage and a fixed one.
Most home buyers typically choose fixed rates due to the excellent financial stability they offer. You know your payments will not change for the life of the mortgage.
If you are confident you’ll move relatively soon, an adjustable-rate mortgage might be a better option. You will likely have lower mortgage payments.
You can get an adjustable-rate mortgage fixed for the first five years, offering initial stability. You can always refinance into a fixed-rate loan if you don’t move.
The introductory period can last up to ten years. However, at the end of this period, the interest rate will undergo an annual change as soon as the introductory term expires.
For example, a 5/6 ARM comprises fixed payments for the first five years and then becomes adjustable after-year five.
Adjustable rate loans offer several options for the initial fixed period. For example, you can opt for 5/6, 7/6, or 10/6.
There will be advantages and disadvantages for adjustable and fixed-rate loans. The choice for most borrowers will come down to their financial circumstances.
Final thoughts on choosing a mortgage term
When comparing loan terms, looking past the interest and seeing the entire financial picture is essential. There are pros and cons of paying off a mortgage early.
Home buyers should always choose a mortgage term that makes sense at the time. Moving into a loan term that could make you struggle would be a significant mistake. For some, paying off a mortgage early makes sense; for others, it does not.
If you choose a 15-year mortgage, you’ll pay off the loan faster but have much higher loan payments.
For most buyers, the perfect mortgage term is a 30-year fixed loan. It offers the lowest payment with optimal stability. You can comfortably make your payments and possibly invest elsewhere besides a mortgage.
Only choose a shorter mortgage term or an adjustable rate when you know you’ll be able to afford the larger payments.
Borrowers should always err on the side of caution regarding finances. When comparing loan terms, looking past the interest and seeing the entire financial picture is essential.
Bill Gassett is a nationally recognized real estate leader who has been helping people buy and sell MetroWest Massachusetts real estate for the past 35 years.