From choosing a neighborhood to selecting a real estate agent, there are a lot of decisions that go into buying a home. Once you’ve zeroed in on your dream property, the next step is figuring out what kind of mortgage term is the best fit for your budget.
Many would-be homeowners prefer to go the traditional route with a 30-year fixed loan but it’s not your only option. Before you embark on the journey to home ownership, it’s helpful to know how the different financing products stack up.
Factors for a 15-year mortgage
If you’re not interested in stretching your mortgage payments out over several decades, a 15-year mortgage may be the way to go.
This type of loan carries a fixed interest rate that’s typically lower than a 30-year term. Since you’re paying off your home in half the time, you’ll shell out a lot less in interest in the long run and you’re building equity at an accelerated pace. There is a trade-off, however, since your monthly payments are usually higher.
While it’s certainly tempting to try and knock out your mortgage debt as quickly as possible, a shorter loan term won’t work for everyone. If there’s a chance that your income could drop significantly in the future, for instance, you have to ask yourself whether you’d still be able to cover your monthly obligations.
Another drawback to consider is how a higher payment impacts your ability to further your other financial goals, like saving for retirement or funding your child’s college account.
30-year mortgage worthwhile?
On the other side of the coin is the traditional fixed rate 30-year loan. This is overwhelmingly the most popular choice for homebuyers because it offers the lowest payment.
If you’re just starting out in your career or you’re trying to pay down student loans and credit card debt, opting for a smaller payment makes sense if you need a little more flexibility in your finances. Plus, you always have the option of refinancing to a shorter loan term in the future.
The one thing you need to be aware of is that even though 30-year mortgage rates are still hovering near historic lows you’ll pay more in interest over the life of the loan.
Let’s say you find a house you love for $200,000 and lock in a 30-year loan with a rate of 4.2%. Assuming you don’t pay anything extra toward the principal, you’ll fork out around $352,000 to clear the loan with a monthly payment of $978. Had you gone with a 15-year loan at a rate of 3.2%, your payments would shoot up to about $1,400 a month but you’d pay roughly $100,000 less in interest.
Other mortgage alternatives
Although they’re not quite as popular, there are some alternatives to 15- and 30-year fixed rate loans.
Adjustable rate mortgages got a bad rap during the fallout from the housing crisis but they seem to be making a bit of a comeback. With this kind of loan, you pay a fixed rate for a set period of time, usually three, five, seven or 10 years.
When the loan resets, the interest rate adjusts based on the market rate and payments typically increase as well. If you’re planning to refinance or sell the home before the reset date, this kind of loan could actually yield some savings but it’s important to review the risks carefully before you sign on the dotted line.
Another less frequently used option is the interest-only loan. These loans can have a fixed or variable rate and borrowers only make payments toward the interest for a set period of time. Once the interest-only period ends, you’ll have to start making payments on the principal as well.
This kind of loan has its benefits, especially if you think your income is going to make a big leap in the future. There is, however, a potential downside since payments will increase substantially if you’re not able to refinance.
Finding your perfect mortgage match is all about knowing how each kind of loan works and gauging how well it fits with your current situation. If you rush into a decision without thinking things through, you could be setting yourself up for some major money headaches down the road.