The fixed rate mortgage with a 30 year term has traditionally been the most popular used by home buyers in the past. But today's generation of home buyers may be well advised to consider a 20-year mortgage. There are several advantages to doing this.
The biggest advantage is the significant interest saved over the term of the loan. Let's say you bought a home and took out a $200,000 mortgage with a 30 year term and an interest rate of 4.75%. The monthly payment would be about $1,043 and the total interest paid over the life of the mortgage would be about $175,600.
But instead, you could borrow the same $200,000 at 4.5% interest rate for a 20-year mortgage. Mortgages with a 20 year term can come with an interest rate that is about a quarter of a percentage point lower. The monthly payment on this mortgage would be about $1,265 and the total interest paid over the life of the mortgage would be $103,670. But take a closer look at the difference and it is surprising. The 20-year mortgage in this example has a monthly payment that is only $222 higher. But the amount of interest paid is almost $72,000 less than the total interest paid on the 30-year mortgage, which is a significant savings.
Another advantage of a 20-year mortgage is that it will be paid off earlier. This can be a big advantage for young home buyers who are planning to have children. They can be free of mortgage payments just at the time their children going to college. This means they'll have more cash flow in time to help pay tuition bills.
But some home buyers will need to start with the more affordable monthly payment of a 30-year mortgage but want the savings of the 20-year mortgage. They can take out a 30-year mortgage and make a few extra payments each year, which will lower the loan balance more quickly producing almost the same savings of the 20-year mortgage. You can calculate your situation with tools online like this.
Just make sure to instruct your lender in writing that the extra payments are to be used only to reduce the loan balance.
Check in later this week when I'll tell you what works for homeowners who are looking to refinance their current mortgage.