Not all home loans are the same, and mortgage terms can vary significantly. That's why understanding how home loans work is so important. Knowing how different loan terms and types of mortgages affect your budget can help you choose the right home loan for your needs. Let's take a look at how different loan terms work, what they mean for your monthly payment, and how they affect your total borrowing costs.
UNDERSTANDING MORTGAGE TERMS
When you take out a mortgage, the loan term is the maximum amount of time you have to repay the money you borrowed, plus interest. For example, a 30-year mortgage gives you 30 years to pay off your home loan. However, you can always make extra payments or pay off your mortgage early to save on interest.
If your financial goals change, refinancing may allow you to switch to a shorter or longer loan term. Refinancing replaces your mortgage with a new mortgage that may have a different interest rate and monthly payment. Closing costs apply when you refinance, so be sure to consider whether the benefits outweigh the costs.
How long are home loans? In the U.S., the most common home loan term is 30 years. At Fibre Federal, we offer mortgages with terms of 10, 15, 20, and 30 years. The right term for you depends on your budget, long-term plans, and how quickly you want to build equity.
The chart below compares the advantages and trade-offs of common mortgage terms:
Mortgage Term | Monthly Payment | Total Interest Paid | Equity Growth |
10 Years | Highest | Lowest | Fastest |
15 Years | Higher | Lower | Faster |
20 Years | Moderate | Moderate | Moderate |
30 Years | Lowest | Highest | Slowest |
The shortest mortgage term lenders offer is 10 years, while the longest is 40 years. While 30-year mortgages are the most popular option, terms longer than 30 years aren't common. A 40-year loan may give you a lower monthly payment, but it usually has stricter qualification requirements and a higher interest rate, meaning you'll pay significantly more interest over time.
HOW MORTGAGE AMORTIZATION WORKS
Mortgage amortization is the process that determines how much of your monthly payment goes toward the principal and interest over the life of the loan. When you start making payments on your loan, a larger portion goes toward interest. As you continue paying down the loan, more of your payment goes toward the principal.
Amortization affects how quickly you can build equity. Because more of your payments go toward interest in the beginning, your equity grows slowly at first. Later, as more of your payments go toward the principal, you build equity more quickly. Making extra payments can increase your home equity, reduce the amount of interest you pay, and potentially help you pay off your loan sooner.
The chart below shows how principal and interest are allocated:
Loan Stage | Payment Allocation | Equity Growth |
Early Years | More interest, less principal | Slower |
Middle Years | More balanced | Moderate |
Later Years | More principal, less interest | Faster |
HOW MORTGAGE TERMS AFFECT INTEREST RATES
When comparing mortgage terms, it's important to look at the annual percentage rate (APR) rather than just the interest rate. The APR includes the interest rate, loan fees, and mortgage points, giving you a more complete picture of your borrowing costs.
The length of the mortgage term can have a significant impact on your APR. Short-term fixed-rate loans of 10 or 15 years usually have lower APRs because they're considered less risky and are repaid more quickly. On the other hand, longer loan terms of 20 or 30 years typically have higher APRs because the longer repayment period extends the loan and increases the lender's risk.
Here are the key differences between shorter and longer mortgage terms:
Short-term mortgages (10 to 15 years)
Typically have lower APRs
Have higher monthly payments
Cost less in total interest
Long-term mortgages (20 to 30 years)
Typically have higher APRs
Have lower monthly payments
Cost more in total interest
With adjustable-rate mortgages (ARMs), your interest rate can increase or decrease over time based on market conditions. With fixed-rate mortgages, your rate is locked in and won't change over the life of the loan. Other factors can also affect your interest rate, including your credit score, loan-to-value (LTV) ratio, down payment amount, and current market conditions.
HOW MORTGAGE TERMS AFFECT MONTHLY PAYMENTS & BORROWING COSTS
The loan term you choose doesn't just affect your APR; it also affects your monthly payment. A longer loan term of 30 years allows you to spread out your payments over more time, giving you lower monthly payments. This can make your mortgage easier to fit into your budget, and it may even give you the flexibility to afford a higher-priced home.
If you finance a home with a shorter term, you'll pay off your loan balance sooner. Although a shorter term typically gives you a higher monthly payment, it often comes with a lower APR and allows you to build equity in your home more quickly.
A longer loan term can lower your monthly payment, but it can significantly increase your borrowing costs. The longer your repayment period, the more total interest you'll pay.
The chart below compares the monthly payment and total interest paid for a $400,000 fixed-rate conventional mortgage at 6% interest for 15- and 30-year terms.
Mortgage Term | Monthly Payment | Total Interest Paid |
15 Years | $3,375.43 | $207,576.92 |
30 Years | $2,398.20 | $463,352.76 |
A 30-year mortgage can cost more than twice as much in total interest as a 15-year mortgage. That's why it's important to choose the shortest loan term that you can comfortably afford.
WHEN TO CHOOSE A SHORT-TERM MORTGAGE
A short-term home loan can help you save money and build equity faster, but it’s not the right choice for every borrower. A 15- or 20-year mortgage may be a good fit if:
You Can Afford a Higher Monthly Mortgage Payment
Although a shorter loan term will increase your monthly payment, it could help you save tens of thousands of dollars in interest over the life of your mortgage, depending on your loan balance. It can help you become mortgage-free sooner and free up money for other goals, like planning for retirement.
You Want to Build Equity Faster
With a 15-year mortgage, a larger portion of your payment goes toward the principal each month. This allows you to build home equity more quickly than you would with a longer loan term. Having more equity can give you additional borrowing options in the future, like a home equity loan or HELOC, which can be used for home improvements, debt consolidation, or other major expenses.
You Don’t Plan to Stay in Your Home Long
If you expect to sell your home within a few years, a shorter mortgage term may help you pay down your loan balance more quickly. This could leave you with more equity when you sell, potentially increasing the amount you can put toward your next home.
WHEN TO CHOOSE A LONG-TERM MORTGAGE
A long-term mortgage of 20 to 30 years helps you spread your loan payments over a longer period. A longer loan term may make sense when:
You Want a Lower Monthly Mortgage Payment
A 30-year loan provides more time to pay off your home, which lowers your monthly payment. This can give you more breathing room in your budget to cover daily expenses, build an emergency fund, contribute to retirement savings, or work toward other financial goals. Lower monthly payments may also make it easier to qualify for a home that fits your needs.
You Want the Flexibility to Make Extra Payments
Choosing a longer-term mortgage doesn't mean you have to pay it off slowly. You can make additional payments toward the principal whenever your budget allows. This gives you the benefit of lower monthly payments while allowing you to pay off your mortgage ahead of schedule if your financial situation changes.
You Want to Buy the Most House You Can Afford
A longer loan term may increase the amount you qualify to borrow by lowering your monthly mortgage payment. This can give you more flexibility when choosing a home and help you find one that truly fits your needs. It may allow you to purchase a larger home or choose a property in a preferred neighborhood.
Frequently Asked Questions
Can you change your mortgage term?
Yes. You can change your mortgage term later by refinancing your home loan. Keep in mind, however, that refinancing may change your interest rate and involve closing costs, so it's important to compare your options before making a decision.
What's the difference between a fixed-rate and adjustable-rate mortgage?
With a fixed-rate mortgage, the interest rate stays the same throughout the life of the loan, and your principal and interest payments won't change. An adjustable-rate mortgage (ARM) offers a fixed interest rate that may be lower than fixed-rate mortgages for an introductory period. After that, the rate can increase or decrease over time based on market conditions.
What is the average mortgage term?
The most common mortgage term is 30 years. However, many lenders also offer mortgages with terms of 10, 15, and 20 years.
Should I get a 15- or 30-year mortgage?
It depends on your budget and financial goals. A 15-year mortgage can help you pay off your home sooner, build equity faster, and save money on interest, but it comes with higher monthly payments. A 30-year mortgage offers lower monthly payments, but you'll typically pay more interest over the life of the loan.
Can you pay off a mortgage early?
It depends on the mortgage lender. With Fibre Federal, there are no early prepayment penalties. Paying off your mortgage early could help you save money on interest, depending on your remaining balance.
CHOOSE THE MORTGAGE THAT’S RIGHT FOR YOU
Choosing the right mortgage term is one of the most important financial decisions you'll make when buying a home. That's why comparing different loan terms and considering how long you plan to stay in your home is essential. The mortgage you choose will affect your monthly payment, total borrowing costs, and how quickly you build equity.
Ready to take the next step? Explore our low-rate mortgage loans and find the term that works best for your needs and budget.
