Are You in It for the Short Term or the Long Haul?

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Updated on Thursday, January 24, 2019

A mortgage is not a one-size-fits-all endeavor. Borrowers have varying needs and financial pictures, so home loans come with differing terms to meet these constraints. Mortgages can vary in terms of repayment length as well as whether their interest rates remain stable or fluctuate. Read on to learn more about the different types of mortgages that are available and to gain a better understanding of what choice is right for you.

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Understanding long-term mortgages

A conventional 30-year mortgage designed for borrowers who are prepared to make a long-term commitment on a property, whether it is a primary residence, a vacation home or a rental property. Additionally, for borrowers who are refinancing their current mortgages, a conventional loan can be a real money-saver, depending on how interest rates are looking at the time.

Most 40-year mortgages are conventional fixed-rate loans, and while the low monthly payments may appear attractive at first, that advantage should be weighed against the fact that the lengthened repayment period translates to slower accumulation of equity as well as paying more interest over time.

The benefits of a conventional 30-year mortgage include:

  • Not having to worry about private mortgage insurance (PMI) if you are able to make a 20% or greater down payment — even those who can’t put down 20% initially can have their mortgage insurance removed upon reaching that level of equity
  • Having the ability to apply funds to various types of properties
  • Choosing between fixed or adjustable rates, depending on plans for the future
  • The possibility to qualify for a conventional loan with as little as 3% down, though this will trigger the need for PMI

Disadvantages of a conventional 30-year mortgage include:

  • Interest rates that are typically higher than shorter-term options
  • The potential for paying more interest over time, given the longer life of the loan

Understanding short-term mortgages

Short-term mortgages typically come with repayment periods of five, 10 and 15 years. Borrowers can choose between fixed-rate loans, where the interest rate stays stable throughout the life of the mortgage, or adjustable-rate loans, which fluctuate with the market.

Benefits of shorter-term mortgages include:

  • A lower interest rate than longer mortgages because lenders often see short-term loans as less risky instruments
  • Lower total interest cost because the loan is paid off more quickly
  • A quicker means of building equity in your home

Disadvantages of short-term mortgages include:

  • A higher monthly payment, given that you have a shorter repayment period — this is the flip side of paying less in interest over the life of the loan
  • The possibility of qualifying for a lower amount because your debt-to-income (DTI) ratio will be higher with a larger monthly payment
  • Less extra cash each month

What to consider when deciding on a mortgage loan term

A few things to keep in mind when comparing loan terms:

  • If you’re risk-averse, a 30-year fixed mortgage is your best bet, as it holds no surprises
  • If you’re more comfortable with the unknown — and prepared to deal with increased costs, should interest rates rise — a shorter adjustable-rate mortgage (ARM) may fit the bill
  • Generally speaking, the longer the loan term, the lower the monthly payments — but the more interest you’ll pay over the life of the mortgage
  • Conversely, shorter loan terms require higher monthly payments but carry a lighter interest load, as the debt is paid down more quickly

If savings is a major consideration when you’re making a decision on a mortgage loan term, know that a shorter-term loan will save you more money in the long run for two reasons:

  • Lower interest rates, because lenders consider shorter-term loans less risky
  • Less interest paid over the life of the loan

The length of time you plan to keep your home is a major factor in your decision among the mortgage-loan options out there. Here are a few things to consider:

  • The longer you plan on living in your home, the more a 30-year fixed loan makes sense — particularly if you see yourself being there for a decade or longer
  • However, if you plan a shorter stay in your home and wish to build equity quickly, a shorter-term loan is more likely what you’re seeking, as you’ll also pay less interest over the life of the loan
  • Whichever route you choose, remember the 28/36 rule: monthly housing payments such as mortgage, insurance and taxes should not exceed 28% of your gross monthly income and ideally should be less than that, while your DTI ratio, which compares the amount of money you owe to your income, should not exceed 36%, and ideally should be far less than that

What kind of mortgage loan is right for you?

When choosing a mortgage, you are essentially selecting between the relative safety of a more conventional loan or the risk of an adjustable-rate loan — but that is far from the only element to consider, so let’s break it down:

First-time homebuyers can choose amongst a number of grants and programs aimed at helping them meet their homeownership goals, including

  • FHA loans, which require a FICO score of at least 580 with a 3.5% down payment, debt-to-income ratio of less than 43%, steady income and proof of employment
  • USDA loans, which offer rural and suburban borrowers zero-down mortgages that are backed by the government
  • VA loans, which assist service members, veterans and eligible surviving spouses with their homebuying goals through no–down-payment loans partially backed by the government
  • Fannie Mae and Freddie Mac, which were created by Congress to offer liquidity, stability and affordability by purchasing mortgages from lenders and either holding in their portfolios or bundling them into mortgage-backed securities; meanwhile, lenders use the cash raised to offer additional mortgages.

Established homebuyers should be prepared to ask themselves the following questions:

  • Which loan will cost me the least over time?
  • How does my income affect my eligibility for a variety of mortgage products?
  • How does my credit score affect my eligibility for mortgages?
  • What loan product has the lowest monthly payment?
  • Which one requires the least amount of upfront cash?

Refinancers need to do the following in order to get the best possible rates:

  • Get their credit in great shape by paying bills on time, paying off chunks of debt, reducing DTI, not opening additional lines of credit and obtaining their free credit reports from the three major bureaus — Equifax, Experian and TransUnion
  • Considering a shorter loan term such as a 15- or 20-year mortgage to avoid dragging out repayment
  • Start local before widening the net:
    • First try your current lender
    • Then research lenders in your immediate area, including smaller banks and credit unions
    • Move on to large lenders, including online banks

And retirees are well-advised to keep a few things in mind when considering mortgages:

  • Your income will be assessed through a method called asset depletion, in which the value of all financial assets is totaled, minus the cost of a down payment, with 70% of the resulting figure divided by the number of months in the loan term to arrive at theoretical monthly income
  • Low DTI ratio — no more than 40% of monthly earnings — is desired
  • Credit score is still a large factor, as is occupancy status — primary homes get better rates than second homes

Conclusion

Your personal circumstances will dictate what you need from — and can handle in — the length of a mortgage loan. Make sure to check in with yourself and your family to understand your personal financial picture before beginning the research and application process.

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