To Avoid Paying Additional Interest, Don't Get A 40-Year Mortgage
Posted on: 28 August 2015
40-year mortgages give young individuals a chance to purchase a home and have very low monthly payments. Because these loans last 10 years longer than traditional 30-year mortgages, homeowners are able to spread their repayments out and reduce their monthly payments. If you're purchasing a home, and want to build up equity and reduce how much interest you pay, though, forgo a 40-year mortgage and opt for a shorter 30-year one.
40-Year Mortgages Include Lots of Interest Payments
All mortgages include interest payments, which account for a sizeable portion of homeowners' payments. Homeowners pay more interest on 40-year mortgages than 30-year mortgages, however, for the following reasons:
- the loan lasts 10 years longer, so homeowners pay interest for an additional decade
- mortgage rates on 40-year mortgages are typically higher than on shorter mortgages, sometimes by as much as 0.5 percent
- payments are lower, reducing how much homeowners pay towards principle
30-Year Mortgages Have Reasonable Payments
30-year mortgages offer shorter terms, lower mortgage rates and larger monthly payments, which all reduce how much interest is paid. The increase in monthly payments, however, isn't large.
For example, according to Bankrate's calculator, if you took out a $150,000 mortgage with an interest rate of 5 percent over 30 years, your monthly payments would be $805.23. Even if you were able to find a 40-year mortgage for the same amount without a higher interest rate, your payments would only drop down to $723.29. A difference of less than $82 a month shouldn't make or break your budget if you're considering purchasing a house.
30-Year Mortgages Build Equity Faster
Because less money is paid towards interest with 30-year mortgages, they let homeowners build equity faster than 40-year mortgages do. Having equity in your home gives you the flexibility to:
- keep the money you've invested in your home when you sell it
- refinance to pay for your children's college tuition, a vacation or home improvement project
- sell your home for less than you paid for it, if it goes down in value
If you're able to pay more than your monthly payment, you could build up equity just as quickly with a 40-year mortgage as with a 30-year mortgage. Anything you pay beyond your monthly payment will be used to lower your principal.
If you can afford to pay more each month, though, there's little reason to take out a 40-year mortgage. After all, the main benefit they offer is lower monthly payments. Instead of paying more than your payment each month, you could:
- take out a 30-year mortgage that has a lower interest rate
- pay down points at closing, thus reducing your mortgage rate
- save up to make a larger down payment, which would lower your loan amount
15-Year Mortgages Have Much Higher Monthly Payments
If a shorter loan helps homeowners build equity faster, getting a 15-year mortgage might seem logical. 15-year mortgages help homeowners pay off their mortgages much faster than either 30- or 40-year ones, but their monthly payments are much higher. Using the above example, the monthly payments on a 15-year mortgage at an interest rate of 5 percent for $150,000 would be $1,186.19 -- 32 percent higher than a 30-year mortgage and 39 percent higher than a 40-year mortgage. Few people can afford to pay an additional $381 or $463 a month.
As you look at houses and begin to prepare for all the expenses that come with homeownership, it may be tempting to lower your monthly payments as much as possible by getting a 40-year mortgage. You will pay less in interest and build equity faster, though, if you opt for a more common 30-year mortgage -- and your monthly payments won't be that much higher.
For more information on taking out a mortgage, visit a site like http://www.firstmortgagecompany.net.
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