Original author: Mia Taylor
When it comes to home buying, the 30-year fixed-rate mortgage has become the unofficial standard, an option utilized in the vast majority of purchases.
But how did this financial instrument grow to be the go-to for countless Americans? More importantly, does opting for a non-standard term, such as a 20-year mortgage, give any advantages? The answer to the second question depends on what matters most to you as the buyer: smaller monthly payments or paying less interest.
The lengthy-term of a 30-year-mortgage translates to lower monthly payments, making homeownership more accessible and affordable. This helps explain why the 30-year-mortgage became the standard.
“The original 30-year mortgage was offered as a way for people to be able to afford homes after the Great Depression,” explained Dave Sullivan, vice president of marketing for People Driven Credit Union. “Most people appreciate the security of knowing the payments are as low as possible.”
But the 30-year mortgage also dominates the market because it puts more money in the lender’s pocket over the life of the loan.
“Lenders prefer to have a borrower take out a 30-year mortgage as the default mortgage term because a longer-period mortgage term means more interest payments by the borrower, and hence it’s a more profitable product for the lender to sell,” said David Reischer, a real estate attorney and CEO of LegalAdvice.com.
The debate between a 20-year-mortgage and a 30-year mortgage rests on the tradeoff between a lower interest rate or a lower monthly payment, said Matt Hackett, operations manager for Equity Now.
A 20-year loan typically comes with a lower interest rate, leading to reduced expense for the buyer over the life of the loan, explained Hackett. Because the loan is shorter, however, be prepared to make higher monthly (or semimonthly) payments.
For borrowers who have excess monthly cash flow, a 20-year-term may allow the loan to be paid off quicker and with less total money out of pocket, said Hackett.
Conversely, buyers with 20-year mortgages face steeper payments.
“If your financial situation changes abruptly it can jeopardize your ability to make the high monthly payments,” said Mike Giamou, cofounder of Medallion Capital Group. “Another downside of a shorter mortgage term is the decreased flexibility to tackle other debt, to make improvements to your property, or to build your savings.”
In recent years, with interest rates particularly low, many borrowers are looking for ways to reduce their mortgage term and pay off the mortgage earlier, said Ralph DiBugnara, president of Home Qualified.
“Shorter-term mortgages will always be more popular in a low-interest environment,” explained DiBugnara.
At the same time, Craig Martin, senior director with J.D. Power’s mortgage practice, suggests consumers are becoming more educated and demanding more transparency from the financial entities and firms they deal with, including mortgage products and offerings.
“It will be critical that lenders are prepared to go beyond just providing the ‘off the shelf’ product,” said Martin. “Those that fail to empower customers to make the best possible decisions risk losing their trust and business.”
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Image: Tom Rumble
This article originally appeared on Policygenius.