30 years… 15 years… “I’m looking to buy a house, and my mortgage broker asked me what loan term I want. How do I choose!?”
Choosing the term of your loan is a huge financial decision when it comes to purchasing a property, each having their own set of “pros and cons”. However, what may be a positive trait for one buyer, may not necessarily be a positive thing for another buyer. It is very important to understand your own personal situation in determining which factors are, in fact, pros and cons for you.
What does a typical, 30 year fixed conventional loan look like?
Well, let’s break down some terms first.
Loan life “30 year”. This is as plain as it sounds, in that it’ll take 360 months, or 30 years to pay off the original loan balance if the payment (loan amortization) schedule is followed exactly. The same would go for a 15 year, too.. just 180 months of payments.
Fixed. This is a really important part of the loan categorization. There are fixed and variable/adjustable rate mortgages, typically. A fixed rate mortgage will keep the same interest rate for the entire life of the loan. So, if you lock in a 5% rate now, that will be the rate you have for the life of that loan. This means that if rates for new mortgages go up to 8% in the future, it doesn’t matter because you locked in at 5%. Similarly, if the rate falls to 2%, your loan will not go down. You would need to refinance, to change your rate.
Conventional loans are typically loans under the Fannie Mae and Freddy Mac umbrella of loans. They are the most common types of loans you’ll probably encounter. Conventional loans can accommodate down payments as low as 3%, with a qualified borrower and loan amount.
So, with all of that… what are the differences between a 15 and 30 year fixed Conventional mortgage?
Well, the BIGGEST difference is solely that the loan balance will be paid off in half the time.
A lower interest rate may be offered for a 15 year loan, because from the bank’s perspective, the borrower is less risky because the bank will get their money back in a shorter period of time. This really depends on the market, and what can be worked out with the mortgage broker. It is definitely something worth looking into if considering a 15 year loan.
A 15 year loan will have a higher monthly payment requirement than a 30 year mortgage with the same initial loan amount. This just comes down to simple math. There is always a risk in this approach, however. If something were to happen, and you couldn’t make the higher payments associated with the shorter term loan, the bank would still be able to come in and foreclose the property. There are debt to income ratios that your mortgage broker should be able to run and make sure that these payments are well within your ability to pay currently, but understanding that risk with a higher payment is important.
When choosing any length of loan, make sure you have a clause that says there is no early repayment penalty. This could be a good loophole to getting a “30 year” mortgage, but paying what a 15 year would have required. This is my personal favorite, because the rate differential between a 15 and 30 year loan isn’t big enough to outweigh less risk in securing a 30 year term length, for me.
The next consideration would be what the purpose of the purchase is. Will this property be your primary residence? Do you want to AirBnB it out? Is this a rental property? Is it a rental that you also live in? For each purpose, you’ll have to model out your costs each month and forecast out normal as well as worst case scenarios for income, including rental income if applicable. Are you comfortable with the results if you choose a 15 year? A 30 year?
I go in to each property with an investor mindset, rather than a homeowner mindset. This has shifted my priorities to being able to keep as much of my cash as possible, in order to address repairs to the property while living in them, then transition them into full rentals. I would rather take a higher mortgage at today’s current rate of about 3.5% and use cash to make repairs, than tie up all my cash in the mortgage payments and use credit cards that have 17%-25% interest rates. This keeps my monthly required costs lower, and is less risky, should a financial hardship hit.
I know others who go into purchasing a property with a homeowners’ mindset, where the idea of being debt free is the primary objective.
Whatever facts and circumstances fit your situation, should guide your decision.
KSA Properties 