A Shorter-Term Home Mortgage Can Save a Bundle

Once upon a time, everybody got 30-year mortgages. They were like station wagons with paneling, color TV and knowing that your parents walked miles in the snow to school each day. It was just the American way.

Today, 30-year mortgages remain popular, but many people are beginning to recognize the advantages of 15- and 20-year mortgages as well.

In a nutshell, shorter-term mortgages can save you money, while longer terms can allow you to buy a bigger house.

How much money can you save with a 15-year or 20-year mortgage? The numbers could knock your socks off.

Let’s look at a 9.3%, $150,000 fixed-rate loan. If you went with the traditional 30-year term, your monthly payments would run $1,239. Assuming you kept the mortgage for its full life, you would pay a total of $446,206, or the $150,000 principal plus $296,206 in financing costs.

With a 20-year mortgage, your payments would rise to $1,379, but your total cost falls to $330,881. That saves you $115,325 compared to the 30-year mortgage.

Drop another five years off that loan and you come up with monthly payments of $1,548 and a total cost of $278,692. You save $167,514.

What’s the catch?

To qualify for shorter-term mortgages, you need to earn more money or buy less house.

The annual income you’d need to qualify for this $150,000, 30-year mortgage, for example, is about $51,000, assuming that the bank only allows you to spend 28% of your income on housing. To qualify for the same loan with a 15-year term, your income would have to exceed $66,000.

If you have sufficient income to qualify for a shorter-term mortgage, you’d be wise to consider whether you’d be better off with the shorter-term loan or with a bigger house. If you earned $66,000, for example, you could qualify for about a $180,000, 30-year mortgage versus the $150,000, 15-year loan.

If the $30,000 difference could buy a home that’s better suited to your family’s needs, it could be better to buy the bigger home for both personal and financial reasons.

The most compelling financial argument is simply this: If you move more often because you didn’t buy enough house, you will lose about 6% of your home’s value each time you transfer residences--simply through realtors’ commissions. The usual sales commission on a $200,000 home works out to about $12,000.

The other possible disadvantage of a shorter-term mortgage is simply the higher monthly payments. If you have a financial reversal that strains your budget, these costs can be troubling. You can often solve these monthly payment problems by refinancing the home, but that, too, is costly. Typically, fees on a refinance can cost between 1.5% and 2.5% of the loan’s value. And, of course, you are subject to prevailing interest rates, which may be better or worse than when you took out the original mortgage.

However, there is another option.

Many lenders will allow you to simply prepay your 30-year loan. And that can give you many of the cost savings of a shorter-term mortgage as well as the financial benefits of having lower monthly payments when you need them.

Not all loans allow for early repayment, though. So you would be wise to ask about whether any restrictions or prepayment penalties would apply to your loan.

How does prepayment work? If there are no restrictions, it is usually as simple as sending in as much extra cash as you can afford each month. Some lenders will ask you to specify on the payment coupon that you’d like the extra amount to go to paying off principal rather than to next month’s payment.

On a fixed-rate mortgage, the extra payments will go to reducing the balance of your loan, and that will cause you to pay the loan off faster.

Extra payments are also used to reduce your mortgage balance with an adjustable-rate loan, but they can also cause reductions in your monthly payments.

Here’s how: The payments on your adjustable loan are recalculated at regular intervals to account for interest rate changes. At that time, the bank determines how much you need to pay each month to pay off the loan over the remaining months of the 30-year period. Assuming interest rates have not risen sharply, the lower loan balance is likely to cause the monthly payment to be pared.

You then have the option of continuing to pay more than required each month and further reducing the required payments. This is sometimes an attractive option for those who plan to retire before their mortgages are paid off.

It is important to note that some institutions also now offer 40-year mortgages for those who need payments that are even lower than on the 30-year loans. But, generally, these end up costing consumers a lot more money and give them only marginally lower payments.

The Quicker the Better Here’s how much your monthly payments and total payment would be on a 9.3%, $150,000 fixed-rate mortgage, depending on how long you take to pay it off. Figures are rounded to the nearest dollar.

Qualifying Monthly Total Term income payments payment 15 years $66,355 $1,548.29 $278,692 20 years $59,086 $1,378.67 $330,881 30 years $53,120 $1,239.46 $446,206 40 years $51,077 $1,191.80 $572,064

Source: Great Western Bank.