Is a Reduced Term a Better Option for Borrowers?

February 9, 2016

The 30 year fixed rate mortgage is the most popular home loan product, but that doesn’t mean it’s the best option for every scenario. Borrowers may assume that’s the mortgage they want, but often this is because they aren’t familiar with the many other choices available to them.

Here are a few questions to work through with your clients to determine whether a shorter term, 15 or 10 year mortgage might be a better alternative.

What are your financial goals related to your property?
How long do you plan to live in this home? Do you hope to be mortgage free as soon as possible? Is it important to you to minimize the amount you pay in interest?

By only making interest payments for 10 or 15 years rather than monthly for 30 years, the amount paid overall is greatly reduced. In addition, mortgage rates for the shorter term loans tend to be lower when compared to 30 year financing. Choosing a shorter term loan can greatly reduce the cost of home financing over the course of repayment.

What would you do with the difference between the 30 year payment and a shorter term payment?
Some homeowners look at the shorter term loan as a way to consistently build wealth over time. They are concerned that if they opt for the lower payment of a longer term loan, the difference will simply be spent here and there. With a shorter term mortgage, those funds are used each month to increase the amount of equity in their home (when considering this strategy it’s important to remember that while historically real estate values tend to increase, there is no guarantee that your home’s value will go up, or that it won’t decrease).

Other borrowers prefer to select the lower payment, favoring some other investment for the additional amount that would be devoted to the monthly payment on a 10 or 15 year mortgage.

Would money be very tight with a shorter term?
Because the amount borrowed is repaid over a shorter period of time, the monthly payment is higher with a 15 year or 10 year mortgage. Even if a borrower can qualify for the larger payment, it may put too great a strain on the monthly budget, and cause undue stress. It’s important that they carefully review their spending and thoughtfully consider how much they can allocate each month towards the mortgage payment.

Encourage them to consider the non-essentials such as travel, entertainment, dining out, and shopping for items such as electronics or clothing. It’s all too easy to say it’s no problem to forgo these extras for a few years during the initial excitement of buying a new home, but after a time the feeling of being “house poor” can be frustrating.

A good option for borrowers in this situation could be to plan to make additional payments towards principal each month. They can choose an amount less than the increase to a 15 year payment and one that is comfortable for them. This will help pay down the loan faster and pay less in interest overall, without the commitment of the higher monthly payment.

Photography by [Rancz Andrei] ©

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