Mortgage term is a very important factor because the time it takes to pay off your loan, the mortgage term, will have a significant impact on your bank account.
Why Does Time Matter?
Interest income for a lender is a function of two variables:
- The interest rate,
- Mortgage term.
The longer the mortgage term, the higher the bank’s interest income. Borrowing money from a lender is a zero-sum game because every dollar the bank wins is a dollar you lose, and vice versa. Therefore, it is very important that you consider what we’ll call the “time factor” in your borrowing decision.
Mortgage Term – Understanding the Time Factor
The easiest way to understand the time factor is counting the number of periodic payments you’ll make (for most mortgages, 1 month = 1 period). Here are some common mortgage terms and their periodic payment schedules:
- 30 Year Mortgage = 360 Periodic Payments (30×12)
- 25 Year Mortgage = 300 Periodic Payments (25×12)
- 20 Year Mortgage = 240 Periodic Payments (20×12)
- 15 Year Mortgage = 180 Periodic Payments (15×12)
The easiest way for me to illustrate the impact of time on your mortgage is to show you an example, so let’s compare two mortgages that have the exact same interest rate of 5% and a balance of $100,000.
A 30 year fixed mortgage will have 360 payments of $1,073.64. Multiplying the two numbers together gives us a product of $386,510.40. That is how much you’ll end up paying the bank over 30 years. Let’s compare it to a 15 year fixed mortgage, that has 180 payments of $1,581.59. Multiplying the two numbers gives us a product of $284,686.20. Thus, it’s now very apparent that repaying the loan 15 years faster saves you $101,824.20. That’s a pretty penny! Wow!
How to Use the Time Factor to Your Advantage
You now know that paying the mortgage off faster will save you money. However, you also saw that the 15 year payment was 47% bigger than the 30 year payment. This is what keeps most people from getting a shorter term, even though it’s better to pay off the loan faster. If you can fit it within your budget, and if you have no other investment opportunities that can yield a return higher than the interest rate charged by the lender, then try to fit a shorter term mortgage payment into your budget.
There are a few things you can do to save money on interest. However, we’ll talk about that later. Here, we’re discussing how to compare mortgages to get the best deal, and you do that by comparing different loans with the same repayment period.
What I want you to do is review lenders’ offers, side by side, and make sure the loans you’re comparing have the same mortgage term (length). Don’t just compare a 30 year fixed offer to a 20 year fixed offer from the same lender. First, you need to select the mortgage term that most closely fits your lifestyle and then compare mortgages, of the same length, across different lenders.
The advantage of comparing loans with the same number of periodic payments is that you’re comparing apples to apples. Make sure to compare loans the way I’m teaching you because that is how you get a good deal! And again, I encourage you to spend a lot of time researching what mortgage term is right for you because not only will it let you stay within your budget, but you will be preparing yourself for a better negotiating experience.