For years, the 30-year mortgage has been seen as the gold standard for American homeowners. In fact, according to Freddie Mac, a federally-backed mortgage guarantor, an overwhelming 90% of today’s homeowners opt for a 30-year mortgage to pay back their home loan.
However, home-buying trends are shifting, with Americans starting to delay homeownership due to an aversion to accumulating debt and a rise in remote working lifestyles.
With these new priorities and timelines in mind, is the 30-year “old reliable” approach still the best option for today’s homeowners, or is a 20-year mortgage preferable?
There are a number of factors to examine when deciding which mortgage repayment time frame is best for you. Let’s take a look at some of the top considerations for each.
Things to Consider When Choosing a Mortgage Loan Term
Something to consider when selecting a mortgage term is your age. If you’re in your twenties to mid-thirties, you have a long road ahead of you to increase your earning potential and pay off your mortgage over the long term. When your mortgage is paid off, you’ll be relatively young to enjoy the fruits of having this large piece of debt fulfilled and owning your home outright.
Conversely, if you’re in your forties or higher, you may not want to have debt and mortgage payments for thirty years. You’re more likely earning an income in line with your potential and may want to own your home outright sooner. If you have children, you may not want to risk passing a mortgage onto them.
Monthly Mortgage Payment
Because you’re paying for a mortgage over a shorter time period, a 20-year mortgage term results in a higher monthly mortgage payment. Therefore, it’s essential to consider your income, monthly expenses and saving goals when choosing a mortgage term.
Can you comfortably afford a larger monthly mortgage payment? Does doing so still permit you to cover all your bills and expenses while maintaining your saving goals? If so, you may want to consider a 20-year mortgage.
If your income situation is tighter and you’d prefer to have a low monthly mortgage payment, a 30-year mortgage would likely be the better option.
While a 30-year mortgage will result in a lower monthly payment, it will end up more costly cumulatively when compared to the 20-year mortgage. This is because you’ll be paying interest on your mortgage for an extra ten years. Furthermore, interest rates for 20-year mortgages are typically lower. Simply put, the 20-year mortgage incurs considerably less interest than the 30-year mortgage.
While you can write mortgage interest payments off your taxes, interest is still money paid to a bank rather than toward the house’s principal.
A 20-year mortgage is designed for you to pay off and own your home outright in 20 years, while a 30-year mortgage is designed to do the same in 30 years. Therefore, with each monthly payment, you’re building equity at a faster rate with a 20-year mortgage than a 30-year mortgage.
If your goal is to build equity in your home more quickly, the 20-year mortgage is a better option. With more equity, you increase your financial net worth, can take out a more substantial home equity loan and can tap into greater equity for another mortgage or other financial pursuit.
The Pros and Cons of a 20-Year Mortgage
- Pay off your loan sooner: With a 20-year mortgage, you’re making larger payments in a shorter timeframe. So, your loan will be paid off a full ten years earlier compared to a 30-year mortgage.
- Faster equity buildup: Because your timeframe is only 20 years, you gain more equity in your home each month than you would with a 30-year mortgage.
- Reduce total interest: 20-year mortgages generally offer lower interest rates than their 30-year counterpart. Furthermore, the mortgage loan is for a relatively short time period, resulting in less interest over the long haul.
- Higher monthly payments: The primary disadvantage of a 20-year mortgage is having a higher monthly payment. Boosting the amount of principal you pay each month allows you to substantially pay down the principal on your home, resulting in a shorter loan period overall. This restricts your access to cash on a monthly basis, so if your income is lower or your other expenses are too high, a higher monthly payment may be unmanageable.
The Pros and Cons of a 30-Year Mortgage
- Lower monthly payment: A 30-year mortgage results in a lower monthly payment than a 20-year mortgage. Because you’re spreading out the fulfillment of your mortgage over a longer period, you can reduce your monthly bill. This is especially attractive to those still arriving at their earning potential or those with considerable other expenses.
- Easier to repay early: Since you’re giving yourself extra time to pay off your mortgage, it might be easier to pay ahead each month. This gives you a comfortable cushion and might result in paying off your mortgage significantly sooner than expected!
- Higher total interest: With a 30-year mortgage, you’ll likely have a higher interest rate compared to a 20-year mortgage. Additionally, you’ll be making monthly payments for ten years longer, so you’ll pay considerably more interest cumulatively.
- You’ll pay off your home more slowly: If you pay just the minimum monthly payment throughout your mortgage term, it will take you ten more years to pay off your mortgage than if you went with a 20-year mortgage.
- Less equity buildup: Similarly, since you’re more slowly paying off your home, you’re building equity more slowly.
All in all, a 20-year mortgage results in less interest paid than a 30-year mortgage, both because of advantageous interest rates and an overall shorter repayment period. For example, if you decide to take out a $250,000 mortgage with a 20-year term, you will likely secure an interest rate of around 2.9%. Over the term of your loan, this would lead to a total of around $80,000 in interest paid. However, if you took out a 30-year mortgage for the same amount, your interest rate would likely be around 3.3%, which would result in around $144,000 interest paid over the term of the loan. The approximate difference of $64,000 shows the advantage of choosing a 20-year mortgage over a 30-year mortgage, though the monthly payments will inevitably be higher with a 20-year mortgage.
20 vs. 30-Year Mortgage for First Time Home Buyers
Nowadays, many people are becoming first-time homebuyers later in life. Taking into consideration previously mentioned factors — specifically age, monthly payment and equity buildup — it may be better for an older first-time homebuyer to select a 20-year mortgage. If they can afford a higher monthly payment, they can build equity more quickly and pay off the house sooner.
Consider these tips for first-time homebuyers:
- Be realistic about your budget.
- Take steps to maintain and strengthen your credit.
- Get pre-approved before making an offer.
- Build an emergency fund with at least 3 months’ worth of expenses.
- Ask yourself if you’re prepared to stay in your future home for at least five years before selling. If not, it may not be the best time to buy a home.
Which Path Is Best for You?
When selecting a mortgage term length, there are a variety of factors to consider, such as your age, budget and personal homeownership goals. However, every homebuyer’s situation is different, and it’s important that you feel comfortable with whatever mortgage term length that you choose, whether it’s 20 or 30 years.
If your main priority as a homeowner is having the lowest monthly payments possible, then you might want to opt for a 30-year mortgage, with the knowledge that you will ultimately pay thousands of extra dollars in interest.
However, if you are eager to start building equity in your home and can afford a higher monthly payment, you may want to choose a 20-year mortgage. Not only will you own your home sooner, you will also end up paying significantly less in interest over the term of the loan.
Our team of experts at Capital Bank is ready and able to discuss the various options available to you and help you determine your best path. Give us a call today to take the next step on your home purchasing journey!