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How to Choose a Home Mortgage Loan Term

By Michele Lerner

homeWhether you’re buying a home or refinancing your current home, you may assume your choices for financing with a fixed-rate home loan are limited to a 30- or 15-year term. While these are the most popular loan choices according to the Mortgage Bankers Association (MBA), many lenders offer mortgage loans for almost any loan term you choose.

The MBA says that 15% of all mortgages for refinancing homeowners were for non-traditional terms in June 2012, while only 2% of mortgages for a home purchase were for non-traditional loan terms. In fact, 85% of purchase loans were 30-year fixed-rate loans.

If you’re considering refinancing, a non-traditional mortgage term of 20, 10, or even an oddball term of 17 or 23 years might be attractive because you can time your loan payoff to a particular date, such as your retirement or what would have been the payoff date of your original 30-year loan.

Loan Term Options

Customized loan terms have been available for as long as mortgage loans have existed, particularly from small community banks and credit unions. These days, some of the larger mortgage lenders have jumped into offering individualized mortgage loans. For instance, Quicken Loans heavily advertises its “YOURgage” program, which allows borrowers to choose a loan term from 8 to 30 years with a fixed rate. These loans are available for $25,000 to $417,000. If you are a homeowner, you can refinance up to 95% of your home value, and if you are a buyer, you can purchase a home with a down payment as low as 5%.

While custom terms of, for instance, 7 or 17 years are not always available from the bigger financial institutions, some lenders such as Chase Mortgage offer fixed-rate loans for 10-, 15-, 20-, 25-, 30-, and 40-year terms.

Shorter loan terms and alternative loan terms have become more popular in recent years for two reasons: First, extremely low interest rates make the monthly payments on shorter mortgages more affordable to borrowers. Second, the recession and scary levels of unemployment have led many consumers to embrace the concept of eliminating all debt, including mortgages.

Why Choose an Alternative Loan Term?

There are several reasons why you may want to choose an alternative loan term:

  • Less Interest. Shorter loan terms tend to be more popular with refinancing homeowners rather than buyers. This is because these homeowners have been paying down their loan balance for several years and want to stay on track to pay off their home within the original time frame of their first loan – typically 30 years. If you have a 30-year mortgage and have been making payments for 11 years, you may not want to refinance into another 30-year loan because this means you will be paying interest and making mortgage payments for a much longer time. You can save thousands of dollars in interest payments with a shorter loan term and use that money for other investments.
  • Convenient Payoff Date. In addition to wanting to stick to your mortgage schedule, you may want to consider a different loan term so that your mortgage payoff date coincides with your retirement date or when your child starts college. Some refinancing homeowners want their new loan to end when their original loan ends, and therefore shift to a 20-year mortgage if they’ve had their current loan for 10 years.
  • Budget Constraints. Both buyers and homeowners may want to choose a customized loan term in order to find the best fit between their housing budget and their mortgage term. For example, if the payments are too high on a 15-year loan, they might be affordable on a 20-year loan, even if the interest rate is slightly higher.

mortgage application

How to Choose a Loan Term

Whether you are a buyer or a refinancing homeowner, your loan term decision should be made in the context of a financial plan. Decide how much you can afford to spend on your monthly mortgage payment before you begin discussing loan options with a lender. Even if a lender says you can qualify for a larger mortgage or for a shorter term loan, you may have other ways you would prefer to spend your money.

Next, think about how long you intend to stay in your home and what your future spending needs will be for children, college, or retirement. Even if you plan to sell your home within five to seven years and want to keep your monthly payments low, remember that with a shorter-term loan you’ll build equity more quickly and therefore generate a larger profit when you sell.

Comparing Loan Features

You should compare your loan options in several ways:

  • Interest Rates and Fees. Some lenders offer alternative loan terms at a higher fee than standard loan terms, so be sure you know how much you have to pay before opting for a specialized loan term. Interest rates are lower on shorter-term loans, but the spread between them changes as often as mortgage rates change. Typically, the difference between a 30-year and a 15-year loan is wider than the difference between a 20-year and a 15-year loan. Your lender may charge the same interest rate for a 20-year loan and a 23-year loan, so be sure to compare all possible loan terms before deciding which one works for you.
  • Amortization. Your lender can prepare amortization tables for a variety of loan terms and rates to show you the principal and interest at various points in your loan. With a shorter loan term, you begin paying down your principal faster; however, during the first few years of a 30-year fixed-rate mortgage, your payments are almost entirely interest. An amortization table can show you how much less you would pay in interest if you opt for a shorter loan term.
  • Monthly Payments. Your monthly payments vary widely according to your loan term. Typically, your mortgage principal and interest payment are higher with a shorter term loan, but because interest rates are lower on those mortgages, the payment may not be as high as you think.

Consider a $200,000 mortgage by comparing 30-year and 10-year loan terms. On a 30-year fixed-rate mortgage at 3.37%, your monthly principal and interest would be $884, while on a 10-year fixed-rate loan at 2.75%, your monthly principal and interest would be $1,908.

After five years, the loan balance on a 30-year loan at that rate would be $178,610 as opposed to $105,193 for the 10-year loan. You would save $89,280 in interest payments by choosing the 10-year mortgage due to the lower interest rates over the shorter term of the mortgage.

Remember, while paying less in interest is a good thing, and shortening your loan term allows you to pay off your mortgage faster, your mortgage interest tax deduction will be reduced and will eventually disappear. Make sure you plan for potentially higher taxes if you choose a shorter loan term.

Final Word

When selecting a loan term, don’t forget to consider the importance of other financial goals, such as paying down credit card or student loan debt and saving for college or retirement. Also, keep in mind that you need the income to qualify for the higher loan payments associated with a shorter-term loan, so you may not be approved for a short loan term if your debt-to-income ratio doesn’t fit within the lender’s guidelines. You can always achieve the goal of paying off your mortgage earlier by voluntarily paying extra on the principal.

How long is your mortgage loan term? Do you wish you’d chosen a different term?

Michele Lerner
Michele Lerner, author of "HOMEBUYING: Tough Times, First Time, Any Time," has been writing about personal finance and real estate for more than two decades for a variety of publications and websites including Bankrate, Investopedia, Insurance.com, National Real Estate Investor, The Washington Times, Urban Land, NAREIT's REIT, and numerous Realtor associations.

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