If you’re a first time home buyer or even in the process of buying your third home, you soon realize you’re encountering no small amount of choices to make. In what part of town should you buy? Are schools more important than your commute? The number of decisions you need to make can appear overwhelming. Oh, and did we mention the choices about your mortgage?
Getting Pre-Qualified is your First Priority
The most important part of the mortgage process is getting your loan approval. Yes, there are plenty of interest rates from which to choose and maybe you want to pay points and maybe you don’t. And your down payment will also be a concern depending upon how much you can or should put down.
Many first timers opt to put down as little as possible so they might choose an FHA loan with a 3.5% down payment. If you’re selling your current home and simultaneously closing on your next, how much of the proceeds should you use for your down payment? 10 percent? 20 percent? More?
Discussing your options with your loan officer will quickly provide you with enough information to make the right choices. The first priority regarding your loan, however, is your approval. The next consideration is the length of your loan term.
The 30-Year and 15-Year Loans Examined
When getting interest rate quotes from your loan officer or seeing advertisements online or other media, you’ll likely hear rates advertised for a 30-year mortgage.
The 30-year loan term has been the staple for mortgage lenders for decades and is the most common loan term issued today for all loan types from government-guaranteed mortgages to conventional fare.
The next most common loan term is the 15-year loan. While not as commonly advertised, you can expect to see 15-year rate quotes right alongside 30-year quotes in a lot of advertising. Fifteen-year mortgage rates can be considerably lower than 30-year loan offerings.
How much lower? A common spread between a 30 year and 15 year mortgage is about three-quarters of a percent. If a 30-year mortgage rate is 3.50 percent with one point, then a 15-year fixed rate can be found at 2.75 percent with one point. The difference between the two however is not just in the rate, it’s the monthly payment and the amount of interest paid to the lender.
For example, a 30-year fixed rate at 3.50 percent (APR 3.53%) on a loan amount of $250,000 yields a $1,122 monthly principal and interest payment. A 15 year, $250,000 loan at 2.75 percent (APR 2.80%) gives you a payment of $1,696.
Yes, the 15 year rate is lower, but the shorter term increases the payment by $574 per month. That’s a big difference. So why do people choose a 15-year loan instead of a 30-year?
Interest savings. Over the life of each loan, the borrower with a 30-year loan pays just under $154,000 in interest to the lender. The 15-year loan however, only gives $55,280 to the lender in the form of interest. That’s a savings of $98,720! And that’s why borrowers consider a 15-year loan instead of a 30.
Looking just 10 years into the future of the loan, the 30-year loan balance is $186,762 and the 15-year loan shows only $95,003 is left to pay!
10-Year, 20-Year, and 25-Year Loan Terms
Sometimes however, borrowers don’t have a choice between the two loan terms. The 15-year loan monthly payments are so high that the borrowers no longer qualify for the mortgage.
Lenders often allow loan terms in five year increments from 10-year terms to 30. That means a lender can provide a 10, 20 and 25-year term in addition to the traditional choices. Most lenders don’t advertise these loans and many times even the loan officers themselves aren’t aware of their existence. But they’re there.
If you don’t like paying a lender $154,000 in interest and the 15-year payments are simply too high, take something in between. Here’s what the 10, 20 and 25-year terms look like when compared side-by-side based upon that same $250,000 loan.
Term Rate APR* Mo. Pymt Interest Paid
10 yr 2.50% 2.57 $2,356 $32,720
20 yr 3.25% 3.29 $1,417 $90,080
25 yr 3.375% 3.40 $1,234 $120,000
Adding these three additional loan options gives you a broad range of monthly payment levels to choose from. If you want to save on interest charges but can’t quite stomach the huge 15-year loan payment, consider a 20- or 25-year term. If you simply can’t stand to be in debt for long and want to pay much less interest, then a 10-year is more to your liking.
The process of buying a home is riddled with choices, and now we just gave you a few more. But you can profit from these choices. We can’t give much advice on the color of your carpet, but at least we can give you options to potentially save you thousands of dollars in interest. Along with your choice of carpet color, you’ll appreciate your choice of loan terms each and every month.
*All rates used in these examples are based on the following:
- $250,000 loan amount
- All monthly payments include principal and interest only (no taxes/insurance/HOA dues).
- $500,000 sales price/appraised value
- $800 in finance charges
- Credit score 740