Which Mortgage Loan Option is Best for You?

When it comes to mortgages, you can choose how long you want to pay because mortgages come in different lengths. Of course, certain types of mortgages require you to have better credit than others. But, assuming your credit is good enough to have your choice of mortgages, let’s look at the different mortgage loan options and discuss how you can choose the best one for you.

Fixed rate mortgage options

A fixed rate mortgage has the same interest rate and monthly payment for the length of the loan. A fixed rate mortgage is the best option for a homebuyer who plans to live in their home for at least 10 years. With a fixed rate mortgage, you’ll enjoy the stability of having the same mortgage payment every month.

Fixed rate mortgages come in 10, 15, 20, and 30 years. Interest rates typically go down as the mortgage length goes down. For example, a 30-year and 20-year mortgage interest rate may be 3.75%, while the 15-year and 10-year is 3.25%. Even though interest rates are lower on shorter-term mortgages, monthly payments are higher. But, the benefit is that you’ll pay much less interest over the life of the loan.

Looking at the Numbers

On a 30-year $150,000 mortgage at 3.75%, your monthly mortgage payment would be $695.00 and you’d pay more than $100,000 in interest over the life of the loan. On the other hand, a 15-year mortgage for the same amount at 3.25% would have a monthly payment of $1,054 but you’d only pay $39,721 in interest over the life of the loan. You’d save more than $60,000 in interest by going with the shorter-term mortgage.

Why don’t more people choose a mortgage with a short term? Because they can’t afford to. In our example above, the monthly mortgage payment on a 15-year mortgage is $359 more than the monthly payment on the 30-year mortgage. Considering the other expenses associated with homeownership, like property taxes and homeowne’s insurance, an extra $359 each monthly might be impossible.

Prepaying Your 30-Year Mortgage

You don’t have to be locked into a 15-year mortgage to pay off your home in fewer years. Instead, you can make an extra mortgage payment each month and receive similar results. You’ll still save a significant amount of interest, but you wouldn’t be locked into making a higher mortgage payment during the months you can’t afford it.

Based on our example above, if you send an extra $100 every month, you’ll pay off your mortgage in just more than 24 years and you’ll save $23,083 in interest.

If you choose to send more than your scheduled mortgage payment, watch out for prepayment penalties. Some mortgage lenders require you to pay up to six months of interest or a percentage of your mortgage if you pay off your loan too soon. Prepayment penalties often apply during the first few years of the loan, so check your loan documents for details on the prepayment penalty.

Which Mortgage Should You Choose?

Pick the mortgage with payments you can afford. Though you can save money with a shorter mortgage length, the payments may be too much for your income. It’s better to get a 30-year mortgage and send extra payments when you can afford to. That way you get the benefit of paying your mortgage early (if you can) without being locked into high monthly payments.