When getting a mortgage – what term should you select? 30 years, 20 years, 15 years or somewhere in between?

When you are getting a mortgage whether it is for the purpose of purchasing a home, or refinancing your existing home, you need to decide which term (length of the loan) is right for you.

Before I answer the question we should compare the advantages and disadvantages of selecting each term. It is also important to state that according to Freddie Mac 90% of homeowners choose the 30 year fixed rate mortgage.

30-year fixed rate mortgage

Advantages

• Offers the lowest monthly payment compared to the other terms as it is paid back the slowest – allowing you to save money each month.
• Offers the most flexibility as you can always send extra money each month towards principal to pay off the home, and loan sooner.

Disadvantages

• This loan is stretched out for 30-years so you end up paying more interest than with a 15 or 20-year fixed rate mortgage.
• The first few years of your payments are more interest than principal – if you want to attack your principal balance faster you need to send in additional principal payments.
• Interest rate is higher compared to a 15-year, or 20-year mortgage loan.

20-year fixed rate mortgage

Advantages

• Offers a slightly better interest rate than a 30-year mortgage.
• The home, and loan gets paid off 10 years faster compared to a 30-year mortgage.
• Saves 10 years of interest compared to a 30-year mortgage.

Disadvantages

• Has a higher monthly payment than a 30-year mortgage.
• Interest rate isn’t significantly lower than a 30-year mortgage, yet the loan is due back 10 years sooner.
• Risk vs reward may not be worth it compared to a 30-year mortgage – when you are set to pay something back 10 years sooner it really has to be worth it with the interest rate, and the 20-year mortgage doesn’t always reflect this benefit compared to a 15-year mortgage which does offer a significantly lower interest rate compared to a 30 year fixed rate mortgage.

15 year fixed rate mortgage

Advantages

• Offers the lowest interest rate as compared to a 20-year, or 30-year mortgage.
• More of your money goes towards principal each month compared to a 20 or 30-year mortgage.
• Saves you the most interest compared to a 20 or 30-year mortgage as the loan is paid back 10 years, or 15 years faster depending on which option you choose.

Disadvantages

• As the loan is scheduled to be paid back in 180 months (15 years) compared to 240 (20 years) or 360 months (30 years) it has the highest payment compared to the other two options.
• Unlike a 30-year mortgage where you can send in more money when you can each month towards principal – with a 15 year mortgage you are obligated to make this payment each month no matter what.
• If you have a sudden change in income / life circumstance – it will be harder to pay this payment each month compared to a 30-year or 20-year mortgage.

Mortgage terms

It is also important for me to explain that when speaking to your mortgage professional / lender you are not stuck with these 3 terms (30, 20, or 15 years). Generally speaking, you can select any term that works for you. For example, if you are refinancing, and you have 21 years remaining on your current mortgage term you can refinance into a 21-year term. Keeping the term at 21 years will not extend your mortgage, and you can pick up right where you left off preferably at a reduced interest rate.

The answer to which term to select depends on your tolerance for risk. ?

If you are ok with the higher monthly payment that comes with a 15-year fixed rate mortgage you will be rewarded with a significantly lower interest rate. With interest rates still being low on a 30-year mortgage, and if you plan on staying in your home for the next 30 years – this is the safest option of all 3 discussed today, remember with this safety comes the cost of paying back more interest over the life of the loan. As the 20-year term falls in between – for this example we will not discuss the risk tolerance here.

When deciding which option is the best option for you may want to consult with your CPA, tax preparer, or financial advisor, etc. to determine if this is something that may, or not make sense for your short / long term financial plan, and objective.

Steven Paul Ross