What difference does a loan repayment term make to how much you’ll pay for a home? Quite a bit.
For starters, your monthly payment could be drastically different because of your loan term — the length of your loan — even though you’re paying the same purchase price.
And, your loan term can add tens of thousands of dollars in total interest paid — again, even though you’re paying the same principal amount.
It can even affect the interest rate itself.
Experimenting with our mortgage comparison calculator can help you see your loan length’s effect on your homebuying budget.
“Term” is your mortgage lender’s word to describe the length of time you’ll take to repay your home loan. The most common loan terms are 15 years and 30 years.
Stretching the price of your home across 30 years, which totals 360 monthly payments, typically means you’ll have lower monthly payments. This means you may be able to afford a more expensive home than you would with a shorter term.
But there’s a catch: More time to pay off your home means more time for your lender to collect interest. While you’re making lower monthly payments, you’re paying a lot more in mortgage interest than you would on a 15-year loan.
The trade-off seems simple enough:
- 15-year loan terms require higher monthly payments but cost less over time
- 30-year loan terms lower your monthly payments but cost more in the long run
But there’s more at stake than your monthly budget and long-term costs.
If you can afford its higher monthly payments, a 15-year loan offers several advantages:
- You build equity faster: Each month, you’d pay off a larger chunk of your housing debt, increasing the amount of equity, or ownership, you have in the home. With significant equity, you may be able to take out a home equity loan or home equity line of credit (HELOC) to pay for renovations or additions, or to cover non-housing related expenses
- You could get a lower mortgage rate: Lenders take a smaller risk on 15-year mortgages, which can mean you might qualify for a lower mortgage rate
- You could cancel PMI sooner: On a conventional loan, you can cancel private mortgage insurance (PMI) once you have at least 20% equity in your home. You’d reach this landmark sooner with a shorter term loan than a 30-year mortgage
As you can see, paying more each month on a shorter-term loan can create new ways to save beyond the simple math of paying less interest.
A 15-year loan’s faster payoff also has a few drawbacks:
- Less flexibility: Sure, you can afford the higher payment now, but what if your income drops in a few years? A higher payment would be harder to make on less money. You could refinance to a 30-year loan at that point, but you’d pay closing costs on the new loan. And you may not qualify at that point
- Less money available for non-housing expenses: Paying more for your house each month leaves less money available in your budget for other kinds of investing, saving, or different financial goals
- Your price range may shrink: A 15-year term’s higher payments may disqualify you for homes you could afford with a 30-year loan
This is why it’s important to consider all the angles before choosing your loan term.
A 30-year loan offers:
- More flexibility in your budget: A lower house payment means you could probably save and invest more money each month. And, you’d likely be less stressed making the payment during hard times
- A bigger price range: Lenders have to make sure your house payment fits your budget. Since a 30-year loan gives lenders more time to collect your mortgage debt, you may qualify to buy a larger or costlier home
- You can choose to pay more: You can always pay more than your minimum monthly payment, allowing you to save on long-term interest without committing to a 15-year loan’s higher payments
All this flexibility and borrowing power helps explain why most homebuyers choose 30-year fixed-rate mortgages.
Of course, the lower payments of 30-year mortgages come with costs that include:
- Higher interest rates: On average, mortgage rates for 30-year fixed loans are higher than for 15-year mortgages
- Slower equity growth: You’ll pay more interest than principal in the early years of a 30-year term, which means your equity in the home grows slowly at first
- Higher mortgage insurance costs: If you put down less than 20% on a home, you’ll typically pay a monthlymortgage insurance fee until you have 20% equity on a conventional loan. The longer it takes to reach 20%, the more you pay in PMI
You may find these costs worth paying if they help get you into a nicer and more spacious home. Every borrower should choose a loan term based on all the facts and not just payment amounts.
A mortgage comparison calculator will show the effects of your mortgage term. This is valuable knowledge. But the calculator can’t decide which loan term is best for you.
You’ll have to do that for yourself. Keep these factors in mind as you decide:
- How long will you stay in the home? A 15-year loan lowers your mortgage debt a lot faster, especially in the early years. So you’d have more to cash out if you sold the home within the first three to five years
- Just how tight is your budget? If you’re not sure whether you can afford the payments on a 15-year loan, you probably shouldn’t risk it. This is true even if your lender approves the loan. You know your personal finances better than anyone, so make sure the payment amount is comfortable for you
- Would you consider refinancing? Refinancing gives you a chance to change your loan term mid-stream. You’d pay closing costs on the new loan, but many homeowners find it worthwhile to revise their loan’s term or interest rate to save money once they’re several years into their mortgage. Knowing you can refinance takes some of the pressure off your loan term decision, knowing you can shorten it down the road
- How does your risk tolerance play out? Some consumers hate being in debt, so they prefer a 15-year mortgage that lowers their mortgage balance more quickly. Others get more stressed about making a 15-year loan’s more expensive payments and prefer a 30-year term’s flexibility
Some borrowers have no choice: They can qualify for their loan only with a 30-year term. But there are other ways to save on long-term borrowing costs even with a 30-year loan.
Shorter-term loans, on average, require lower interest rates than longer-term loans because the lender faces less risk. This opportunity for a lower rate adds even more to the long-term savings you’d get with a shorter-term loan.
But choosing a 15-year loan isn’t the only way you can lower your interest rate.
You could also:
- Buy down your rate with discount points: If you can part with the cash, you could lower your 30-year fixed rate somewhat making a one-time payment up front. For instance, you could pay a 1% fee or an extra $3,000 on a $300,000 loan. This could bring your rate down and save a lot if you stick with the loan for a decade or more
- Boost your credit score: Borrowers with higher credit scores can often secure lower rates on 30-year mortgages. Before applying for a mortgage, make sure your credit history is error-free and that you’re keeping non-housing debts low and all bills paid on time
- Lower your DTI: Paying off some debt can also lower your debt-to-income ratio (DTI) which underwriters consider when you apply for a mortgage loan of any term
- Put more money down: Larger-than-required down payments put lenders at ease because you’re putting more of your own money on the line. Less lender risk can mean lower interest rates for you
- Use the right loan: Borrowers with lower credit scores may get lower interest rates with FHA loans instead of conventional loans. Homebuyers with military backgrounds should check out the VA loan program first since these loans typically offer the lowest interest rates and there is no monthly mortgage insurance fee
When you choose a 15- or 30-year loan term, you won’t have to stick with the decision for the full 15 or 30 years.
In fact, many borrowers don’t. They sell or refinance within the first decade of homeownership.
Refinancing hits the reset button on your mortgage debt. You could lock in a lower rate, as borrowers have been doing throughout the COVID-19 pandemic as mortgage interest rates dropped to historic lows. You could also choose a different loan term – or you could do both.
So if you go conservative with a 30-year term now, you could switch to a more aggressive approach and refinance into a 15-year loan later.
Some homeowners do the opposite: They switch from a 15-year term to a 30-year so they can better afford the payments. This strategy can add significantly to how much you’ll pay long-term in interest payments, though, so be sure to read your Loan Estimates carefully before taking this option.
Running the numbers on a mortgage comparison calculator is a good start to figuring out what the right loan term might be for you.
The next step is a mortgage pre-approval, which tells you how much money you’ll likely be able to borrow based on your finances. The whole idea will become less hypothetical once you start seeing the numbers on a page.
And having a pre-approval in hand shows home sellers you’re a serious buyer. It shows that a mortgage lender is willing to back your home purchase for 15 or 30 years.
The Mortgage Comparison Calculator shows cost differences and other comparisons between two loan scenarios. It calculates monthly payments based on the length of the loan, interest rate, and other factors. It also determines your remaining loan balance after a set amount of time in the home.
Loan term: The number of years your lender sets to pay off the loan. The most common loan term is 30 years, but 10, 15, 20, and 25-year loans are available as well. Some lenders can even offer custom terms, such as 12 or 18 years.
Mortgage rate: The rate at which you pay interest on the loan. For instance, a 4% mortgage rate means you pay $4,000 per year, per $100,000 borrowed. Interest is broken up into 12 monthly installments and paid along with principal. A special formula is used to keep your payment the same each month on a fixed-rate loan, even though your principal balance and interest paid are going down each month.
Principal: The dollar amount owed.
Interest: The cost to borrow, which is determined by your remaining principal loan balance and interest rate.
Homeowners insurance: Lenders require you to maintain homeowners insurance, which pays for the home to be repaired or rebuilt in case of fire or another disaster. Most homes cost between $50-$100 per month to insure. Note that this insurance does not include flood or earthquake protection. Those policies can be as much or more than the standard homeowners insurance. If you need such policies, place the total insurance cost in this same box.
Property tax: The amount levied by your local jurisdiction each year when you own property. It’s important to check property tax rates in the place you plan to buy, since this cost can vary widely.