The 30 year mortgage has been one of the most popular loan terms since its inception in the 1930s. Originally created to help boost homeownership following the Great Depression, the 30 year mortgage allowed more people to buy homes at affordable monthly payments, since the repayment period was spread out over three decades. However, despite the lower monthly payments, a 30 year mortgage often means paying much more in interest over the life of the loan when compared to a shorter amortizing product. So when discussing these options with your borrowers, how do you navigate the decision and help them weigh the pros and cons?
Here are a few suggestions and talking points to review when comparing 15 and 30 year loan options with your borrowers:
How long do they plan on owning the home?
For buyers who are just starting out, a 30 year mortgage may seem appealing because the mortgage payments will be lower. However, stretching out a mortgage slows down the accumulation of equity, especially if your first time buyers are using a low or zero money down financing option. The equity position may be important if they plan to sell or refinance the property within the next few years.
To illustrate, let’s say your borrowers choose a 3.5% down FHA loan with a 30 year term, and then decide to sell in 3 years. It’s unlikely that they’ll have a lot of equity built up after only 3 years, since the first few years of a mortgage are mostly dedicated to repaying interest – not principal. Unless the home experienced a dramatic boost in value or they bought at a significantly discount, these hypothetical borrowers probably won’t have much cash to work with when getting their next home.
By contrast, if they had chosen a 15 year mortgage, they could have built up equity faster by having a larger monthly payment (and therefore more money going toward their principal balance). After 3 years, their home sale will likely generate a better profit due to having a higher level of equity.
Alternatively, your borrowers could opt for a 30 year mortgage and make additional principal reduction payments when it is financially feasible, thus freeing them from the commitment of higher monthly payments but still giving them the ability to put more toward principal.
When discussing equity it is important to be sure your clients understand that it is possible that a property’s value may increase, remain the same, or even decrease over a given period of time.
Which is a higher priority – keeping monthly payments low, or reducing overall costs?
The low payment of the 30 year mortgage may make budgeting easier, and avoid financial strain in the short term. If the higher payment of a 15 year loan is manageable, talk to your clients about how they may be able to save considerably on interest charges over the course of repaying the loan both due to the lower rate that generally comes with a shorter term mortgage and because the interest is paid for a much shorter period of time.
Even if the higher payment that comes with a 15 year loan isn’t a concern for your borrowers, it’s worth having them consider whether paying the mortgage off quickly is the best use of their money. With mortgage rates still very low there isn’t a great cost to borrowing for buying or refinancing a home. Your clients may want to think about going with the 30 year loan, and using the additional amount that they would have allocated towards the 15 year payment towards paying off higher interest debts, retirement savings or other investments, or some other purpose.
How much home do they need?
Because the monthly payments on a 30 year mortgage are lower, your clients will likely qualify for a more expensive home when taking out this type of loan rather than a 15 year mortgage. If they need a larger property to accommodate a growing family, or can’t find a home that meets their needs at the lower end of their budget, the 30 year repayment term might make the most sense for now.
Remind your borrowers that no matter what mortgage term they choose, there is no “right” choice for everyone. By thinking through these considerations they will hopefully feel confident that they are making an informed and well-reasoned decision.
Photography by [NOBUHIRO ASADA] © shutterstock.com
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Tags: 15 year mortgage, 30 year mortgage
