The top 5 reasons you should NOT finance a home with a 30-year mortgage
In 1938, the Federal National Mortgage Association (also known as Fannie Mae) was established to add some stability and liquidity to the mortgage industry. Even so, it wasn’t until 1948 that Congress authorized the use of 30-year terms on newly constructed homes and 1954 for existing homes.
So, what made the 30-year loan more appealing than a 15 or 20-year loan? Affordability. More people were able, for the first time, buy a home which became the American Dream. But, just because it may be the most “popular” loan, is it the best loan? Let’s look a 5 reasons you may NOT want a 30-year loan.
- While the monthly payment may be less, the overall result is that you’ll pay more interest compared to shorter-term loans.
- It can take roughly 20 to 22 years of payments before more of your payment goes towards principal instead of interest.
- Most people will refinance to get a lower interest rate every 3 to 7 years back into another 30-year loans, thus starting the process all over again.
- Many homeowners will sell & move in 5 to 7 years with less equity than they would have had with a shorter term mortgage.
- A 30-yr mortgage has a higher rate of interest than shorter term mortgages.
Alternative Options or Stategies You Should Consider
Bi-Weekly Payments
If you decide that you can afford a short term mortgage (as noted below) but the lender says you cannot qualify for that payment, you can go with the 30-year loan but plan to make extra principal payments. There is no required way to do this. I’ve seen people make bi-weekly payments or pay extra with their regular monthly payment or pay extra each quarter or just make an extra payment annually (such as when you get a income tax refund).
Fixed Rate But Shorter Term
Most lenders will offer a 20-year, a 15-year and even a 10-year mortgage option. Inquire about both. It’s been my experience that the interest rate on the 20-year loan is very close to the 30-year loan. A 15-year loan offers the best interest rate. Of course the shorter term means you’ll have a higher payment, so this should be considered.
Adjustable Rate Mortgage
Just because an interest rate can adjust don’t assume that it will always go up. Do your own research. Discuss this option with your lender. Find out what index the rate is tied to and what the interest rate caps are. This can be especially beneficial if you only plan to be in this home for a short period of time.
All-in-One Mortgage
One of the biggest concerns most people have with paying extra principal is that those funds are no longer available in case they need it for an emergency. The All-in-One (AIO) loan fixes that. The AIO is similar to a Home Equity Line of Credit (HELOC) but offers many more benefits. Because of how the loan is structured, it can actually pay off much faster than the typical loan without paying extra!
The All-in-One is very popular in Canada and several European countries. It’s been in the US for roughly 20 years but most people have not heard of it, quite frankly, because most lenders don’t want to offer it. If you’re saving thousands of interest on your mortgage, guess who’s earning less interest? The lender. That’s why you haven’t heard of it.
The AIO has several benefits but it’s somewhat harder to qualify for. Borrowers must have a credit score of at least 700. The debt-to-income ratio cannot exceed 41%. And, the borrower must have liquid assets (i.e. bank accounts, savings, retirement accounts) that equal at least 10% of the proposed loan amount. So, if you are seeking a $300,000 loan, you would need to show proof of assets equaling at least $30,000.
The AIO is also available for investment properties.
Reverse Mortgage
If you are at least 62 years of age (some programs start at age 55), you may be able to qualify for a Reverse Mortgage and enjoy your home free of any mortgage payment. Yes, this can even be done on a home purchase. You can get more information here.
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