When you’re ready to buy a home, the loan options and terms can make the process seem complicated. How long will your loan term be? Do you want a fixed-rate mortgage loan or an adjustable-rate mortgage loan?
Your mortgage lender will explain your loan terms and options to you, and help you choose the mortgage option that best fits your financial needs.
Loan Term Options
Your loan term is the life of your loan, or the set amount of time in which you’ll pay back your loan. A few common loan term options are a 30-year loan, a 20-year loan, and a 15-year loan. For example, with a 30-year loan, if you make your payments on time, you will have paid back the full loan amount, plus interest, in 30 years.
Once your loan term is set, you’ll get an amortization schedule from your mortgage lender. An amortization schedule is a table that shows the progress of how you’ll pay off your mortgage loan. The table breaks down how much of your monthly payments go toward your principal and interest, how much is due, and when it’s due.
Fixed-rate vs. adjustable-rate loans
There are two options for interest rates on your home loan: a fixed-rate mortgage or an adjustable-rate mortgage (ARM). Some loan options are only available as fixed-rate loans, so talk with your lender about what is right for you.
With a fixed-rate mortgage loan, the interest rate you start with will remain the same throughout the life of your loan, unless you refinance your loan down the road.
This means that your monthly mortgage payment will always be the same, unless there are price changes to taxes and insurance.
On the other hand, an ARM’s interest rate will fluctuate throughout the life of your loan. Most ARMs have a fixed initial interest rate period for a specified amount of time at the beginning of your loan term, during which the interest rate remains the same. After the fixed initial interest rate period, the interest rate changes. For example, a common ARM structure is the 5/1 ARM, where the fixed initial interest rate period is 5 years. After that, the interest rate changes annually.
One of the most popular loan options is a 30-year fixed-rate mortgage loan. This means that you’ll pay back the loan over 30 years, and your interest rate will remain the same throughout the life of your loan. But why would you choose a 30-year loan term when you could choose 15? What are the benefits to a fixed-rate mortgage loan? Let’s talk about the pros and cons of this popular loan.
30-year Fixed-Rate Loan: Pros
A more affordable payment
When you compare the monthly payment on a 30-year fixed-rate mortgage loan to a shorter term mortgage, like a 15-year term mortgage, the payments are often smaller and more affordable. The fixed-rate means your interest rate won’t change throughout the life of your loan. But with an adjustable-rate mortgage loan, your rate can change, and could increase your monthly payment.
Let’s look at this in an example on a $200,000 home loan. For a 30-year fixed-rate mortgage with an interest rate of 4%, your monthly mortgage payment would be around $955. For a 15-year fixed rate mortgage on the same house, with the same interest rate, you’d be paying an estimated $1,479 a month. Now let’s change up the interest rate options.
For the same $200,000 loan, with a 30-year term and adjustable-rate, your initial payment might be $955 a month. If you had a 5/1 ARM, you’d pay $955 a month for the first 5 years of your loan. After that, your interest rate would change every year. Let’s say the first year it changes, your rate increases to 5%. That makes your new estimated monthly payment $1,057. If the next year it increased to 6%, your payment would be $1,162.
Flexibility and predictability
With a 30-year fixed-rate mortgage loan, you have the flexibility to pay off your loan faster if you’re able to. But how? Since this type of loan offers you a low monthly payment option, you may actually be financially able to pay a little more than what you owe each month. Maybe you’re able to pay more in September and October, but can only afford your normal payment in November and December. You can do that. Just be cautious if your loan has prepayment penalties, which may penalize you if you pay over a certain amount of your loan balance in one year.
A 30-year fixed-rate loan is predictable, and gives you the “sleep well advantage.” Knowing your payment will remain consistent makes things a little less stressful, and makes it easier to make other financial plans. With this loan, you know that your monthly payment will always be $X. So no matter what happens to interest rates and the housing market, your mortgage loan payment will remain the same. Your payment amount will stay constant. This way, you can do some financial planning to fund other things, like college tuition, buying a new car, or taking a vacation. Your monthly payment can change if your premiums change for your taxes or insurance.
30-year Fixed-Rate Loan: Cons
You pay more interest
Your interest rates on a 30-year fixed-rate loan will be higher, even though it will stay the same throughout the life of the loan. When you get a 30-year fixed-rate loan, your mortgage lender’s risk of not getting paid back is spread over a longer period of time. For this reason, lenders charge higher interest rates on loans with longer terms.
This may seem obvious, but it’s also something to consider: when you choose a 30-year mortgage loan term, you will pay more interest than if you were to choose a shorter loan term. It’s that simple. Yes, a 30-year fixed-rate loan may offer you the lowest monthly payment, but that’s because you’re choosing to pay your loan amount back over the longest amount of time. As long as you owe money back to your lender for your loan, you’ll owe interest, meaning you’ll pay more total interest on a 30-year fixed-rate loan than you will on a 20- or 15-year fixed-rate loan.
As previously before, you pay back your loan on an amortization schedule, which breaks down what you have to pay and when you owe it. Your lender will provide you that schedule. It also breaks down how much of each of your payments will go toward your principal balance and how much will go toward your interest.
Try using an amortization calculator, which you can find online. When you plug in some information about your loan (or the loan you want), it will show you exactly how much interest you will pay based on your loan’s term.
It might not be the right loan for you
A 30-year fixed-rate loan might not match up with your other life goals. Maybe you’d like the end of your loan term and your retirement to coincide. This might mean you want a 20-year loan term, not 30. Is your goal to have the house paid off before (or close to) sending your child off to college? These are important things to consider when you choose a loan term.
When deciding what loan terms and options are right for you, think about how much of a monthly payment you you’re comfortable with. Also consider what current interest rates are like, and the length of the loan term you want. Your mortgage will be able to guide you through the process, and explain the different options available for your financial situation. A 30-year fixed-rate mortgage loan might be the right loan option to get you into the home of your dreams.