Mortgage Terms - Comparing Rates

While the 30-year fixed mortgage is the most popular choice amongst American homebuyers, there are many other term combinations that may be more financially beneficial.

Depending on the homebuyer’s finances, long-term goals, and other factors, selecting a mortgage with a shorter time horizon could be a better choice. Most people choose a 30-year mortgage because this automatically reduces the monthly payment. However, it also increases the total amount paid for the home. In many cases, a homeowner with a 30-year mortgage may pay more than double what the home was sold for after paying off the mortgage. This is because homebuyers spend much more time making interest payments, which can add up to tens or even hundreds of thousands of dollars over the years.

For some people, the long-term downsides of a 30-year loan are a fair exchange for the financial flexibility it offers in the short term. A 30-year mortgage allows people to afford a more expensive house. This may be very important for homebuyers with specific needs, like wanting to live in a certain school district or near family. In addition, 30-year mortgage payments also free up money for other expenses.

Disciplined homeowners can invest the money that would otherwise go towards their mortgage payments and possibly earn a higher rate of return than the mortgage interest rate. However, most individuals on a 30-year mortgage use the savings to pay for immediate expenses, such as transportation and renovations.

Mathematically, 15-year mortgages are the less expensive option, although the monthly payments are much higher. Since 15-year mortgages have lower interest rates, homeowners pay much less over the life of the loan. Equity also builds up faster in the home. This can serve as collateral for loans or make it easier to refinance the mortgage to get a lower interest rate.

Some people combine the qualities of both mortgage lengths by taking out a 30-year loan and making extra payments when possible. This brings down the mortgage balance faster, reducing the overall amount paid. It also enables the homeowner to divert money to other expenses if necessary.

In addition to selecting the length of the loan, homebuyers can decide if they prefer a fixed- or variable-rate mortgage. The rate type determines how much interest is charged on the loan. As the name suggests, fixed-rate mortgages have a set interest rate that lasts the entire term of the loan. Fixed-rate mortgages can provide some stability, as the mortgage payment will never change. Like mortgage repayment terms, fixed rates can be set for a specific period of time. Generally, the shorter the time period, the lower the interest rate.

In a variable-rate mortgage, the interest rate fluctuates based on the lender’s prime rate, a number based on several factors. If the interest rate falls, the borrower benefits because more of their mortgage payment will be applied to the principal. On the other hand, interest rates can also rise and cost the homeowner more in the long run.

The best rate term depends on both individual and external factors. People who are risk-averse and prefer predictability may opt for a fixed-rate mortgage, even if it is more expensive. If interest rates are high at the time of purchase, a variable-rate mortgage may make more sense, as they are easier to break and convert into a fixed-rate mortgage. This also makes variable-rate mortgages more appealing to individuals who plan to stay in a home for a shorter period of time.