Choosing the best mortgage term

2012-06-23T00:00:00Z Choosing the best mortgage termBy Peter G. Miller CTW Features nwitimes.com
June 23, 2012 12:00 am  • 

QUESTION:

Why not get a 10-year mortgage rather than a 15-, 20- or 30-year loan? Would not the rate be cheaper for the loan with the shortest term?

ANSWER:

It’s true that loans with shorter terms generally mean less risk for a lender, and therefore rates are lower. Moreover, 10-year loans are surely available: As one example, the U.S. Department of Housing and Urban Development says that in fiscal year 2011, the Federal Housing Administration insured 2,053 loans with terms of 10 years or less. In the same period, a total of 1.2 million FHA mortgages were insured.

However, the unemployment rate remains significant, and few people today will stay with a single employer long enough to get the storied “gold watch” for 30 years of service.

In such an environment, there’s great value to lower monthly costs and financial flexibility.

Let’s look at a $100,000 mortgage at 4 percent over 30 years. The rate is fixed. The monthly cost for principal and interest will be $477.42. Now imagine that same $100,000 mortgage but with a 10-year term and a 3.2 percent rate. The fixed monthly cost for principal and interest is $974.87.

The higher cost of the 10-year loan is a tremendous barrier for most borrowers. A better option for most borrowers is a 30-year mortgage with a right to prepay in whole or in part at any time and without penalty. Borrowers with such financing can make bigger monthly payments if they want and thus reduce both the potential interest cost and loan term.

However, if there’s a loss of income, borrowers with the 30-year mortgage are only required to make the standard monthly payment of $477.42 versus a required $974.87 for the 10-year note in this case. That can be a significant difference if times get tough.

So, while I understand the attraction of 10-year financing, I suspect most people would be more secure with a longer-term loan and the right to prepay in whole or in part without penalty.

Email peter@ctwfeatures.com. Due to volume, not all questions may be answered.

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