When you’re ready to buy a home, the loan options and terms can make the process seem complicated. How long will your loan term be? Do you want a fixed-rate mortgage loan or an adjustable-rate mortgage loan?
Your mortgage lender will explain your loan terms and options to you, and help you choose the mortgage option that best fits your financial needs.
Your loan term is the life of your loan, or the set amount of time in which you’ll pay back your loan. A few common loan term options are a 30-year loan, a 20-year loan, and a 15-year loan. For example, with a 30-year loan, if you make your payments on time, you will have paid back the full loan amount, plus interest, in 30 years. Once your loan term is set, you’ll get an amortization schedule from your mortgage lender. An amortization schedule is a table that shows the progress of how you’ll pay off your mortgage loan. The table breaks down how much of your monthly payments go toward your principal and interest, how much is due, and when it’s due.
When buying a home, one of the biggest decisions you’ll make is whether to get a 20 year or 30 year mortgage. While a 20 year mortgage can save you money on interest, a 30 year mortgage has several key advantages that make it the better option for most homebuyers. Here’s why a 30 year mortgage is often the smarter choice
Lower Monthly Payments
The main reason a 30 year mortgage makes sense is the lower monthly payment. By spreading out your payments over 30 years instead of 20, your monthly payment will be significantly lower – often hundreds of dollars per month less. This lower payment provides more room in your budget and allows you to
- Buy more house for your money since you can qualify for a higher loan amount.
- Comfortably afford your other monthly expenses.
- Put extra money toward goals like retirement or your child’s college fund.
For many homeowners, the lower monthly payment is the deciding factor in choosing a 30 year term. It provides financial flexibility that a 20 year mortgage does not.
Time to Grow Into the Payment
One advantage of a 30 year mortgage is it gives you time to grow into the payment. When you’re first starting out, your income may not allow you to comfortably make the higher monthly payments of a 20 year loan. But over the 30 year term, you’re likely to see your income rise through job changes, promotions, raises, etc.
This income growth means the mortgage payment becomes more affordable as time goes on. What originally seemed out of reach on a 20 year loan becomes easy to handle down the road with a 30 year term.
Ability to Pay Off Early
Some argue a benefit of a 20 year mortgage is paying it off faster. But with a 30 year loan, you still have the option to make extra payments and pay off your mortgage early. There’s no requirement that you take the full 30 years to pay it off.
By going with a lower 30 year payment first, you leave flexibility to pay more later if your financial situation allows. Many homeowners end up paying off their 30 year mortgages in 20-25 years simply by making a little extra payment when possible.
Lower Interest Rates
An overlooked advantage of 30 year mortgages are the lower interest rates. On average, 30 year loans offer a rate 0.25-0.5% lower than 20 year loans. This means you’ll pay less interest overall, saving you money.
When you combine the lower rate with the shorter 20 year term, the interest savings largely disappear. This negates one of the main selling points of a 20 year loan.
Lower Refinance Risk
No one can predict what will happen with interest rates over the next 10-20 years. Rates may go up or down significantly during your mortgage term. This affects 20 year loans more than 30 year ones.
If you have a 20 year mortgage and rates drop, you cannot refinance to lower your rate without starting over with a new 20 or 30 year term. With a 30 year loan, you have the option to refinance while keeping a similar remaining term. This allows you to maximize interest savings.
Lower Closing Costs
For some homebuyers, closing costs can make a mortgage unaffordable. Typically, a 30 year loan has lower fees at closing compared to a 20 year for the same loan amount. This reduces the upfront cash needed to buy the home.
Over the life of the loan, the lower fees help offset the higher interest payments. For buyers concerned about closing costs, a 30 year mortgage can ease the burden.
Better Residual Income
Your residual income is the money left over each month after paying debts and other expenses. This leftover money goes toward general living expenses and savings.
With a lower monthly mortgage payment, a 30 year loan leaves more residual income after paying your housing expense. This gives you more room in your budget for things like food, utilities, healthcare, and entertainment.
Potential Inheritance
One final point in favor of a 30 year mortgage is the potential for passing on an inheritance. If you unfortunately pass away with a mortgage still owed, your heirs can sell the home and keep any equity.
With a 30 year loan, more of the equity belongs to you rather than the bank. This gives your loved ones a larger inheritance if the home needs to be sold to settle the estate.
The Verdict
While a 20 year mortgage seems attractive for fast equity buildup and less interest paid, the 30 year mortgage offers advantages that outweigh those benefits for most homebuyers.
The lower payment, flexibility, reduced risk, and increased residual income make the 30 year mortgage the better overall option. For a smooth home buying process and comfortable budget, a 30 year loan is generally the way to go.
30-year fixed-rate loan: pros
When you compare the monthly payment on a 30-year fixed-rate mortgage loan to a shorter term mortgage, like a 15-year term mortgage, the payments are often smaller and more affordable. The fixed-rate means your interest rate won’t change throughout the life of your loan. But with an adjustable-rate mortgage loan, your rate can change, and could increase your monthly payment. Let’s look at this in an example on a $200,000 home loan. For a 30-year fixed-rate mortgage with an interest rate of 4%, your monthly mortgage payment would be around $955. For a 15-year fixed rate mortgage on the same house, with the same interest rate, you’d be paying an estimated $1,479 a month. Now let’s change up the interest rate options. For the same $200,000 loan, with a 30-year term and adjustable-rate, your initial payment might be $955 a month. If you had a 5/1 ARM, you’d pay $955 a month for the first 5 years of your loan. After that, your interest rate would change every year. Let’s say the first year it changes, your rate increases to 5%. That makes your new estimated monthly payment $1,057. If the next year it increased to 6%, your payment would be $1,162.
With a 30-year fixed-rate mortgage loan, you have the flexibility to pay off your loan faster if you’re able to. But how? Since this type of loan offers you a low monthly payment option, you may actually be financially able to pay a little more than what you owe each month. Maybe you’re able to pay more in September and October, but can only afford your normal payment in November and December. You can do that. Just be cautious if your loan has prepayment penalties, which may penalize you if you pay over a certain amount of your loan balance in one year. A 30-year fixed-rate loan is predictable, and gives you the “sleep well advantage.” Knowing your payment will remain consistent makes things a little less stressful, and makes it easier to make other financial plans. With this loan, you know that your monthly payment will always be $X. So no matter what happens to interest rates and the housing market, your mortgage loan payment will remain the same. Your payment amount will stay constant. This way, you can do some financial planning to fund other things, like college tuition, buying a new car, or taking a vacation. Your monthly payment can change if your premiums change for your taxes or insurance.
Fixed-rate vs. adjustable rate loans
There are two options for interest rates on your home loan: a fixed-rate mortgage or an adjustable-rate mortgage (ARM). Some loan options are only available as fixed-rate loans, so talk with your lender about what is right for you.
This means that your monthly mortgage payment will always be the same, unless there are price changes to taxes and insurance. On the other hand, an ARM’s interest rate will fluctuate throughout the life of your loan. Most ARMs have a fixed initial interest rate period for a specified amount of time at the beginning of your loan term, during which the interest rate remains the same. After the fixed initial interest rate period, the interest rate changes. For example, a common ARM structure is the 5/1 ARM, where the fixed initial interest rate period is 5 years. After that, the interest rate changes annually. One of the most popular loan options is a 30-year fixed-rate mortgage loan. This means that you’ll pay back the loan over 30 years, and your interest rate will remain the same throughout the life of your loan. But why would you choose a 30-year loan term when you could choose 15? What are the benefits to a fixed-rate mortgage loan? Let’s talk about the pros and cons of this popular loan.
Fixed vs ARM Mortgage: How Do They Compare? | NerdWallet
FAQ
Why is a 30-year mortgage better?
- Enjoy lower, more affordable monthly payments.
- Free-up cash for savings, retirement, and other needs and expenses.
- Still qualify for higher loan amounts.
- Pay extra each month (when possible) towards the principle balance thus reducing the effective term of the loan.
Does 1% make a difference on mortgage?
Even a 1% difference in your mortgage rate can save you hundreds of dollars each month and tens of thousands of dollars over the course of your loan. Remember, the mortgage rates you see advertised represent the average interest rates that borrowers are offered for home loans at a given time.
What is one benefit to a 30-year mortgage as opposed to a 15-year mortgage?
You’ll likely qualify for a larger loan with a 30-year mortgage. This means you can buy a more expensive house. You want the option to pay off your mortgage faster without being tied down. If you borrow a 15-year loan, you’re committing to a higher monthly mortgage payment for the entire loan term.
How much is a $300,000 mortgage payment for 30 years?
How Much is a Monthly Payment on a $300,000 Mortgage? Expect to pay about $1,798 to $2,201 per month for a $300,000 mortgage with a 30-year loan term, depending on your interest rate and other factors. Learn more about the upfront and long-term costs of a home loan.