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Understanding conventional mortgage terms

Understanding conventional mortgage terms 1

The mortgage term is the length of time that it takes to repay your mortgage in full. It is one of the most controllable variables with your mortgage, but like other factors, it can be a huge determinant in the type of loan that you choose. Along with the loan amount and the monthly payment, it can decide the size of the home that you can ultimately buy. Choosing a mortgage term that fits your income and lifestyle is an important choice. This article will teach you how to do it.

15, 30, and more

Conventional mortgages are available in many different terms, but the most common are 15- and 30-year mortgages. The main difference between shorter and longer term mortgages is the interest rate and principal payment amount. Most conventional mortgages have a fixed rate, meaning that the interest rate is not adjusted over time. However, adjustable rates are also available.

This being said, shorter term mortgages can be seen as beneficial to mortgage lenders, and will, in most cases, allow for a lower interest rate. 15-year mortgages are ideal for those that have a stable career and source of income, as well as a low debt to income ratio.

30-year mortgages allow the homebuyer to plan on saving more in the future, but to ultimately pay more money in interest than what would be paid on a shorter term mortgage. Most mortgages allow homebuyers the ability to “pre-pay” if your income situation changes. This will allow you to pay an amount over your monthly principal on a regular or irregular basis in order to repay your mortgage sooner. A longer term mortgage can also allow a home buyer to purchase a home at a larger price point while knowing that they can pay off the loan amount in monthly payments over time.

Other mortgage terms can be between 10- and 20- years, but they are less commonly used.

Saving money in interest

Because interest is charged over time, a 15-year mortgage will allow the homebuyer to save money because the total amount of interest charged is less than that of a longer term mortgage. The monthly principal on a 15-year mortgage will be higher than a 30-year, but both will add up to the amount of the loan plus interest. If interest is compounded over 30-years, the amount paid would be significantly greater than what is paid on a shorter term mortgage.

For conventional fixed-rate mortgage loans, the interest rate will be fixed over the term of the loan, meaning that it will not increase or be adjusted. Because of this, a longer term mortgage will have a higher interest rate throughout the term of the loan. However, it is beneficial for homebuyers to not have variable interest rates through the term of the loan, especially if it is over 30 years.

Monthly payments

The main difference between shorter and longer term mortgages is the monthly payment. The principal payment amount for both mortgage terms will add up to the full amount of the loan, plus compounded interest. However, the principal of a shorter-term mortgage will be significantly higher and may require a higher source of income or lifestyle adjustment. Longer term mortgages will allow for lower monthly premiums so that the homebuyer can use these savings to pay off debt or save for retirement.

However, a general rule for lenders is that a monthly payment, including principal, interest, insurance, and taxes, should not exceed more than 28% of a homebuyer’s monthly income. This amount, as well as the term, will all be considered during a pre-approval for a mortgage loan.

Mortgage insurance

Many different types of mortgages will require mortgage insurance, at least for a period of time. It can be discontinued after the homebuyer has paid 22% into the equity of a home. It may also be negated by providing a down payment of 20% when purchasing the home.

Because the payments on a shorter term mortgage will be higher, the homebuyer will reach the amount of equity that they need to cancel mortgage insurance sooner than with a longer term mortgage. This is the only way that mortgage term can affect mortgage insurance, as many lenders will require it when borrowing more than 80% of the purchase price, regardless of the term.

Paying off early

Any mortgage can be paid off early. There are other ways to change the length of your mortgage, such as refinancing with your original mortgage lender or a different lender. If you choose to sell the home, the amount of equity that you have in the home can be sold and used to pay off the remainder of the loan amount.

Some mortgages such as a 5/1 Adjustable Rate Mortgage are intended to be paid off early to avoid a large increase in interest rate. Other mortgages may be ended at different times due to relocation, refinancing, and more.

Mortgage terms are one of the reasons that homebuyers are able to work with lenders to find a home that meets their needs and fits into their budgets. Mortgage terms should be approached in the pre-approval process, as they can greatly affect the amount that you will be granted for the loan.

 


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