Should You Choose a Shorter-Term Loan

When you prepare to buy a home, you must decide on your loan's term. Most people get a 30-year home loan so that their payments are as low as possible, but if you want to save on interest, you can apply for a shorter term. You will pay more each month for a 15,20- or 25-year loan but pay the loan off sooner, pay less total interest, and build equity faster. Whether or not to opt for a shorter term depends on your goals and what you can afford.

Long Term Goals

Your life plan matters when it comes to this decision. If you are approaching retirement, you may want your home paid off sooner, so you won't have payments when you are elderly. Maybe you want to build enough equity to be able to downsize and buy your retirement home outright. Perhaps you plan on additions to your house down the line. With a shorter loan, you build equity in a few years, which you can use to take out a VA Home Improvement loan. If this is a starter home and you plan on eventually buying a larger home, owing less on the first home allows you to qualify for a bigger loan with excellent terms.

An Alternative to Shorter Terms

Rather than taking out a loan with a shorter payback period, experts recommend staying with your 30-year loan but paying more than the required payment each month to pay the loan back faster. If you add 1/12 of your monthly payment every month, you add one full payment every year. For example, if instead of paying $800 each month, you make it $867, that's an extra month for the year. If you pay everything directly to your mortgage company, don’t include tax and insurance when calculating the additional amount. The advantage of this method is flexibility. If you have unexpected expenses for one month, you can make your minimum payment and go back to adding extra when you are able. If you suddenly earn less money, you won't be burdened with the larger amount you would have had with a 15- or 20-year loan.

Irregular Extra Payments

Instead of paying a bit more each month, think about making occasional extra payments. Do you get a tax refund every year? If you get paid every two weeks, you may have additional income for some months to put towards your mortgage. Before sending in extra one-time payments, contact your mortgage company. If you just send the money in without telling them to apply it to the principal, they may think you are paying your next month's installment. It would be best if you let them know to apply the extra payment to the principal.

Whether you take out a shorter-termed loan, pay a little extra each month or pay occasional amounts during the year, your credit rating will benefit. If when you look at your household budget, you find you can make extra payments, great. Before doing that, make sure you have a sufficient rainy-day fund first.

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