Here's a "Fast Track Course" on selecting the right mortgage term....
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How Do You Pick The Best Loan Term?
Home mortgage loans are one of the most common sources of financing. Lots of home buyers will put some serious thought into what loan term they should go with. How do your pick the loan term that is best for your financial circumstances? Hopefully, by the time you're done reading you'll have a better sense of direction on that. You can also visit the resource at Maximum Real Estate Exposure for additional guidance.
Numerous lenders offer mortgages for nearly any loan term you desire. Most people, however, assume conventional fixed-rate mortgages are for either fifteen or thirty years. You can use these loans to buy a new home or refinance your current home.
The decision to pick one loan term over another is usually a function of qualifying and income. Many people who have the financial means to qualify for a shorter loan term will go that route. For the average Joe, that is not always possible. In fact, the fifteen-year mortgage term is far from the most used.
As of 2012, the Mortgage Bankers Association reported that eighty-five percent of purchase loans were thirty year fixed mortgages. The thirty-year fixed mortgage has been popular for a very long time. You could call this kind of loan the mortgage standard.
There are, however, other loan terms that could be just as appealing, if not more so. Most people think of loan terms in either five or ten-year increments such as ten, fifteen, twenty, or thirty-year mortgages. Many lenders, however, are now doing odd loan terms.
For example, you may want a loan term amortized over twelve years. Could it be that you know you'll be retiring at that point and want your mortgage paid off? This is just one example of why someone might want a more unusual loan term expiration.
Choices for credit terms
Customized loan terms have been available in many smaller institutions for a long time. It is more recently that some of the larger lenders have joined the fray in customizing their loan periods.
Shorter loan terms and alternative loan terms have become more popular in recent years for a couple of reasons. First, extremely low-interest rates make the monthly payments on shorter mortgages more affordable to borrowers.
Second, the recession from 2008 to 2012 with high levels of unemployment has led many consumers to strive for making their debt load smaller, including mortgages. If a customized loan term is something you desire then it's one of the questions to ask a lender up front whether they will accommodate your needs.
Reasons to go for an alternative loan term
Below are the reasons as to why you want to use an alternative loan term
1. You will pay less in interest
Most people who are refinancing will go for a shorter loan period. The reason for wanting to have a quicker payoff period is very logical. If you have owned a home and have been paying off your loan balance for several years, you'll want to stay on track with your loan payoff schedule.
For example, if you started with a thirty-year mortgage and refinance your loan balance, it is unlikely you'll want to go back to a thirty-year amortization if you have owned the house for five years. You have been paying down your mortgage for five years, so you have only twenty-five left. Many borrowers would either ask their lender for a twenty-five-year loan or go to a fifteen-year mortgage.
So while you may be paying a higher mortgage payment refinancing into a fifteen-year mortgage, you'll be saving thousands of dollars in interest payments with a shorter loan term. Lots of folks like to be able to take those funds and invest in other places where they can make their money grow.
2. It gives a convenient payoff date
As previously mentioned, some homeowners will go with a customized loan payoff date due to some kind of financial milestone. Some of the more common reasons for wanting a specific loan schedule include retirement or paying for your kid's college bill.
When refinancing it is not uncommon for homeowners to select a new mortgage end date that coincides when their original loan date would have ended. So if for example the loan was initially scheduled for a twenty-year payoff they might refinance into a ten-year loan if they have owned their home for ten years.
3. Proper budgeting
One of the most significant considerations for picking an appropriate term for the loan is the financial budget. In both the homes I have purchased I opted for customized loan periods. While I would have loved to go with a fifteen-year mortgage to pay less interest over the life of the loan, I chose a twenty-year loan.
While many buyers would have picked a thirty-year term, I opted for twenty to pay off my loan balance quicker. By choosing the twenty-year term, I got a little bit better interest rate which further saved on interest payments.
You could say there was a fine line between balancing my housing expenditures and keeping my loan term as short as possible.
How to compare loan features
1. Compare the interest rate and fees you'll pay.
Some lending institutions have different fees for different loan programs. It is imperative to compare apples to apples. It is possible that you could be charged higher fees with going with a less than standard loan term.
Interest rates are always lower on loans with shorter lengths. For example, you will get a lower interest rate when you opt for a ten-year loan vs. a fifteen year. The same can be said when comparing a fifteen-year mortgage to one that is amortized over twenty years.
Usually, the interest rate spread between a 30-year and a 15-year loan is larger than the difference between a 20-year and a 15-year mortgage. Different lenders might charge the same interest rate for a 20-year loan and a 25-year loan. This is why comparing different lending institutions becomes so vital. You will need to analyze all possible loan terms before deciding which one suits you best.
2. Loan Amortization.
The lenders you are interviewing can prepare amortization tables for some loan terms and corresponding interest rates to show you the principal and interest at various times during your loan. You can do this when bringing financial documents the lender will need to process the loan.
With a shorter loan term, you'll begin to pay down your principal much faster. Conversely, with a longer loan term such as a thirty-year mortgage, during the first few years, your mortgage payments will be mostly interest. In other words, you won't be paying down your principal balance all that much.
An amortization table could show you how much less you would pay in interest if you chose a shorter loan term.
3. Monthly Mortgage Payments
Your monthly mortgage payments can vary tremendously according to your loan term. Typically, the mortgage principal and interest payment are higher with a shorter term loan. Given the interest rates are lower on these mortgages, the payment might not be as high as you expect.
Keep in mind, that paying less in interest is what most people desire, and shortening your loan term will help you to pay off your mortgage faster. The downside, however, is that your mortgage interest tax deduction will be reduced and will eventually disappear. You'll have to plan for potentially higher taxes if you choose a shorter loan term.
When deciding on a loan term, this is something you might want to discuss with your financial advisor or tax account first. Everyone's economic circumstances are different. What might be great for one person could be completely different than the next.
Heck you might even want to extend your loan term because you plan on making home improvements to the property. It's possible you could add an additional amount to your loan balance to cover the additions that will make your property worth more and enjoyable to you in the process.
Final Thoughts on Loan Terms
When picking a loan term, it is essential you think about your complete financial picture. For this reason, many folks opt to speak with qualified professionals before making such a significant financial decision.
Your financial goals should play a large part in what loan term you decide on. Do you have student loan debt? Have you overextended yourself with credit card debt? Do you need to save for the kid's college? Will retirement be sneaking up on you soon?
These are the type of questions you should be asking yourself when trying to decide which way to turn. What you can qualify for is another consideration. Some people might not even be able to go with a shorter loan term that they desire.
Sometimes you can put yourself in the best of both worlds position. For example, one of my favorite things to do is put money each month towards paying down my principal balance. I am paying off my loan quicker which in turns lowers the amount of interest I will pay throughout the loan.
One loan term may be good for the goose but not for the gander. Do your due diligence to figure out the best option for your financial goals and position.
Other Helpful Active Rain Real Estate Resources
- Most frequently asked mortgage questions - when buying a home it is important to ask a lot of questions and get the answers that make you the most comfortable. See some of the questions most borrowers will ask their lender.
- Why having a buyer's agent is smart - some people have no idea why they should be using a buyer's agent. The least important task of a real estate agent is showing you homes. You should be looking for someone who can provide expert real estate guidance. One of the main functions of a buyer's agent is to provide sound advice.
Look at these additional resources for more helpful financial and real estate advice.
Bill Gassett is a thirty-two year veteran to the real estate industry. He enjoys providing helpful information to buyers, sellers and fellow real estate agents to make sound decisions. His work has been featured on RIS Media, National Association of Realtors, Inman News, Placester, RESAAS, Credit Sesame and others.