Regardless of whether you are buying a home or refining your current home, you can assume that your financing choices with a fixed rate home loan are limited to a period of 30 or 15 years. While these are the most popular loan choices according to the Mortgage Bankers Association (MBA), many lenders offer mortgage loans for almost every loan term that you choose.
The MBA states 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 related to non-traditional loan terms. In fact, 85% of purchase loans consisted of 30-year fixed-rate loans.
If you are evaluating the refinancing, a non-traditional mortgage term of 20, 10 or even an odd term of 17 or 23 years might be interesting because you can dedicate the loan payment to a specific date, such as the pension or what the date would have been of payment of your original 30-year loan.
Customized loan terms are available as long as there are mortgage loans, particularly from small community banks and credit unions. These days, some of the largest mortgage lenders have entered the offer of individualized mortgage loans. For example, 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 the value of the home and, if you are a buyer, you can buy a home with a 5% down payment.
While the custom terms of, for example, 7 or 17 years are not always available at major financial institutions, some lenders like 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 monthly payments on shorter mortgages more accessible to borrowers. Secondly, the recession and the appalling 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 might want to choose an alternative loan term:
- Less Interest Shorter loan terms tend to be more popular with refinancing homeowners than with buyers. This is because these homeowners have paid their loan balance for several years and want to stay on track to pay their home within the original time period 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 that means you will pay interest and pay mortgages 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 payment date . In addition to wanting to comply with the mortgage program, it is possible to consider a different loan term so that the repayment date of the loan coincides with the retirement date or when the child starts college. Some refinancing homeowners want their new loan to end when their original loan ends, and then switch to a 20-year mortgage if they have had their current loan for 10 years.
- Budget constraints . Both buyers and homeowners may want to choose a custom loan term to find the best solution between their housing budget and the duration of the loan. For example, if the payments are too high on a 15-year loan, they could be accessible on a 20-year loan, even if the interest rate is slightly higher.
How to choose a loan term
If you are a refinancing buyer or homeowner, the decision on the loan term 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 start discussing loan options with a lender. Even if a lender states that you can qualify for a larger mortgage or a short-term loan, you may have other ways you would prefer to spend your money.
So think about how much time you want to stay at 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 short-term loan you will build equity faster and then generate more profit when you sell.
Comparison of loan characteristics
You should compare your loan options in different ways:
- Rates and interest rates . Some lenders offer alternative loan terms at a higher rate than standard loan terms, so make sure you know how much you have to pay before opting for a specialized loan term. Interest rates are lower on short-term loans, but the spread between them changes every time mortgage rates change. Generally, the difference between a 30-year and a 15-year loan is greater than the difference between a 20-year and a 15-year loan. Your credit institution can 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.
- Depreciation . 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 start paying your capital faster; however, during the first years of a 30-year fixed rate mortgage, payments are almost entirely of interest. An amortization table can show how much less you pay in interest if you opt for a shorter loan term.
- Monthly payments . Monthly payments vary widely based on the term of the loan. Typically, mortgage capital and interest payments are higher with a shorter term loan, but since interest rates are lower on those mortgages, the payment may not be as high as you think.
Consider a $ 200,000 mortgage comparing 30-year and 10-year loan terms. On a 30-year fixed rate mortgage at 37.3%, capital and monthly interest would be $ 884, while on a 10-year fixed-rate loan at 2.75%, capital and monthly interest would be $ 1 , 908.
After five years, the loan balance on a 30-year loan at that rate would be $ 178,610 compared to $ 105,193 for the 10-year loan. You will save $ 89,280 in interest payments by choosing the ten-year mortgage due to lower interest rates in the short term of the mortgage.
Remember, while paying less interest is a good thing, and shortening your loan period allows you to pay off your mortgage faster, the tax deduction on mortgage interest will be reduced and eventually disappear. Make sure you plan potentially higher fees if you choose a shorter loan term.