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Chapter 6. Terms of the Mortgage

┠What is the term of a mortgage, and how do I choose the right one for me?

┠Is a longer- or shorter-term loan better for me?

What is the term of a mortgage, and how do I choose the right one for me?

Since a mortgage is usually the largest purchase you will ever make, how long it takes to pay it off should be a major concern. The term is the number of years that it will take to pay off the loan if all required payments are made on time and there are no extra payments made. Selecting the proper term can save you more money than any other feature of a loan. Although an increasing number of lenders are offering ten- and twenty-year mortgages, the most common choice from most lenders is between a fifteen-year loan and a thirty-year loan. If you are dealing with a lender offering ten- or twenty-year mortgages, the following considerations apply equally to these terms. Assuming that you can qualify for shorter than a thirty-year term, there are several factors to consider when deciding whether a shorter- or longer-term loan is right for you. The most important is whether you are confident that you can make the higher payment required on the shorter-term loan. Ask your lender what the payments would be on each for the amount that you intend to borrow. If you do not have a lender yet, use one of the online calculators to compute the difference.

Is a longer- or shorter-term loan better for me?

Examine your spending habits, as well as your current and future budgeting. For example, if you are not currently making car payments but plan to buy a new car you will have to make payments on, you have to add the probable car payments to your future expenses. If you eat out three times a week in a good restaurant, you could save hundreds of dollars a month if you cut back to once or twice a week. Once you feel comfortable that you could make the larger payment on the shorter-term loan, go to the next step.

What will you do with the money you save by making the lower payment on the thirty-year loan?

From the Expert

The word save is a poor choice, since most people spend the money difference between the loans.

If you have a specific reason for wanting the lower payment (beyond the financial need for it), such as investing the money, you have to compare the return on the investment to the return on the shorter-term loan versus the longer-term loan. This is something that your financial planner will have to advise you on, taking into consideration your specific circumstances and goals.

If you do not have any special reason for wanting the lower payment, the fifteen-year loan has several advantages. The major advantage to the fifteen-year loan is that the interest rate, as well as the fees, will be lower than the thirty-year loan. When you combine this with the higher payments because of the shorter term, the results are dramatic.

Example: On a thirty-year, $100,000 loan at 7%, you would pay slightly under $5,300 in principal during the first five years. By paying only .25% less for your fifteen-year loan (a fairly standard offering), you would pay just under $21,000 in principal during the same five years. The payment on the fifteen-year loan would be $220 per month higher. By paying $13,200 ($220 x 60 months), you reduce your loan by an additional $17,000, and you only have ten years to go (as opposed to twenty-five).

If you are in your forties or older, it makes sense to have a free and clear home before retirement. Chapter 22 on reverse mortgages shows just how important this can be.

If you do not feel comfortable with the higher payment, all is not lost. You can get the thirty-year loan and make additional principal payments. You will not save as much because of the higher interest rate, but you can still substantially reduce the loan term. It will take more discipline since the additional payments on the thirty-year loan are voluntary, while the higher payment on the fifteen-year loan is required.

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