There are significant financial and lifestyle benefits that can occur when a homeowner obtains a mortgage that is shorter than 30 years or pays off a mortgage faster than 30 years.
A typical mortgage before 1930 typically had a 3 to 5-year term and did not have an amortization period. Instead, mortgages involved paying a series of interest-only payments with one large balloon payment at the end of the term, which was the entire principal of the loan. Unless the homeowner was able to convince the lender to renew the mortgage, they typically defaulted on the loan. This made mortgage lending risky.
The Federal Housing Administration (FHA) was created in 1934 and was built to protect lenders and reduce lending risk. FHA created a number of valuable mortgage services. They created the 30-year mortgage, created Amortization which involves paying off both interest and principal amounts with each payment and reduced the down payment required on new home sales. The FHA began offering 15 to 30-year loans, stretching out payments and making it more affordable for medium-income individuals to buy a home.
The benefit of a mortgage with a shorter than 30-year amortization, is that less money that goes to interest and more money is applied to principal. As a result, the balance is paid down faster, and the mortgage is paid off in less time. For example (Assume a mortgage with an original balance of $250,000).
Total Interest Paid After 5 Years After 10 Years
30 Year Mortgage 53,900 102,200
20 Year Mortgage 48,700 86,900
15 Year Mortgage 43,600 72,300
As can be seen, the interest saved is significant. However, what is more noteworthy is what happens to the mortgage balance with mortgage shorter than 30 years.
Mortgage Balance After 5 Years After 10 Years
30 Year Mortgage 227,900 200,200
20 Year Mortgage 205,800 151,100
15 Year Mortgage 182,700 100,500
The equity build-up is much faster with a shorter mortgage term. The payments for a mortgage with a term shorter than 30 years, will be more than what is required for a 30-year mortgage. However, the payments go to building equity in the property.
PRIMARY FINANCIAL AND LIFESTYLE BENEFITS OF PAYING OFF A MORTGAGE
- Paying off your mortgage can give a strong sense of financial stability;
- Flexibility in your monthly budget
- Protection against an unstable housing market and/or a loss of income
- Peace of mind of knowing and feeling that you are in charge of your family’s finances.
- The freedom to pursue other life choices
If you want to understand the benefits of obtaining a shorter term mortgage give us a call and we can run the numbers for you to see if it fits your financial life and your long term goals.