If you’re trying to decide on a mortgage term, you might be leaning toward the most popular option: the 30-year mortgage. Almost 78% of new mortgages in December 2020 were 30-year fixed-rate loans, according to the Urban Institute.
But the less common 20-year loan comes with some noteworthy advantages. For one, it’ll save you tens of thousands of dollars in interest. Plus, you’ll be able to build home equity faster and become mortgage-free 10 years sooner.
The impact of your loan term
Your loan term is how many years you have to repay your mortgage when you buy a home or refinance. The most popular mortgage terms are 15 years and 30 years, but some lenders offer terms anywhere from eight to 29 years.
Both 20- and 30-year mortgages are fixed-rate loans, meaning your monthly principal and interest payment will always be the same. It can be reassuring to know that one of your primary, ongoing expenses never changes.
Along with selecting the best mortgage lender, your loan term is one of the most important decisions you’ll make when you choose a home loan.
Your loan terms affect:
- How much interest you’ll pay
- How quickly you’ll pay down your principal
- How soon you’ll own your home free and clear
Monthly mortgage payment
If you want the lowest monthly payment, you should choose a 30-year fixed-rate mortgage (or consider an adjustable-rate mortgage, such as a 5/1 ARM).
Here are the differences between a 15-, 20-, and 30-year mortgage for every $100,000 borrowed at varying interest rates. In the example, a 30-year loan costs $119 less per month than a 20-year mortgage, and $244 less than a 15-year loan.
The trade-off: For every $100,000 borrowed, you’ll spend $23,571 more in interest with a 30-year mortgage compared to a 20-year loan, and $34,522 more compared to a 15-year mortgage.
Total interest paid
Using the example above, you can easily calculate the total interest for different loan terms with the same loan amount.
If you want to prioritize paying less interest, choose a 20-year loan over a 30-year loan. The lower rate combined with the shorter term will save you more money over the life of the loan.
For example:
If you get a home loan for $250,000, you’ll pay $82,757.50 in interest with a 20-year term (at 3% interest), and $141,682.50 with a 30-year term (at 3.25% interest). That’s a savings of $58,925.
Learn More: How to Get the Best Mortgage Rates
Equity buildup
You’ll build equity faster by opting for a shorter loan term over a longer one since you’re paying off the principal faster.
You can use home equity in several ways:
- Down payment for a new home
- Home equity loan
- Home equity line of credit
- Cash-out refinance
If you’re looking to tap into your home equity through a cash-out refinance, Credible can help you get started. You can compare our partner lenders in just a few minutes.
How a 20-year mortgage works
When you’re comparing a 20-year mortgage to the more common 15-year and 30-year terms, you’re probably thinking about how much money you could save by going with a shorter loan term.
The nice thing about a 20-year home loan is that it won’t stress your monthly budget as much as a 15-year mortgage.
Pros of a 20-year mortgage
- Saves you money on interest: Expect a lower interest rate on a 20-year mortgage compared to a 30-year mortgage. By saving about 0.25% to 0.40% on your rate and paying off your home loan 10 years faster, you’ll pay much less in interest compared to a 30-year loan.
- You’ll build equity faster: You’ll have to pay more in principal each month to pay down your loan over 20 years instead of 30. But that means you’ll build equity faster. If you have private mortgage insurance, you may be able to get rid of it sooner than if you had a 30-year loan.
- Pays off your home sooner: Perhaps the most rewarding and obvious benefit in choosing a 20-year mortgage over a 30-year mortgage is that you’ll be mortgage-free 10 years sooner.
Cons of a 20-year mortgage
- Requires a higher payment: Paying off a loan in fewer years, even with a slightly lower interest rate, requires you to put more money toward your home each month. That might not be a good thing if you have high-interest debt or you aren’t maxing out your retirement savings.
- Ties up money in your home: Building equity faster isn’t necessarily a good thing. If you need that money later, you’ll have to pay to access it through another loan. Home equity loans, lines of credit, and cash-out refinances carry higher interest rates than first mortgages, and you’ll likely have to pay closing costs on the new loan.
- Gives you less flexibility: When you choose a 20-year loan, you lock yourself into a larger payment each month. The consequences if you can’t make your payments include foreclosure and damaged credit.
How a 30-year mortgage works
In the long run, a 30-year mortgage will cost you a lot more interest compared to a 20-year mortgage. But, it will have a smaller impact on your monthly budget, and with a lower monthly payment, it may be easier to qualify for.
Pros of a 30-year mortgage
- Smaller monthly payments: Paying off a loan over 30 years means you’re responsible for a lower payment. The monthly savings can help you pay off high-interest debt or save more for retirement. It can also allow you to keep a significant savings cushion for home repairs and maintenance.
- Doesn’t tie up as much money in your home: While you’ll build equity much more slowly, you may be able to avoid the costs of home equity borrowing if you need extra cash in the future.
- You’ll have more flexibility: When you choose a 30-year loan, you don’t lock yourself into a larger monthly payment. Instead, you have the flexibility to make extra payments when you can afford it, whether that’s every month or once a year.
Cons of a 30-year mortgage
- Costs you more in interest: You can expect a higher interest rate on a 30-year mortgage compared to a 20-year mortgage. Between the higher rate and longer term, a 30-year loan can be costly.
- You won’t build equity as fast: Most of your monthly payment on a 30-year mortgage will go toward interest for the first several years of your loan term. You may not have as much equity as you’d like if you later want to sell your home and put the proceeds toward a different home. It can also take longer to get rid of private mortgage insurance if you make a small down payment.
- And it’ll take longer to pay off your home: Some people don’t like knowing they’re in debt, even if it has a low interest rate. Without making extra principal payments, you’ll be in a completely different life stage by the time you pay off a 30-year mortgage. Many people consider paying off the mortgage a precursor to retirement, so a 30-year term might not be right for you if you hope to retire sooner.
Which loan term is right for you?
It’s probably clear by now that the main factors you should consider when choosing a loan term are what you can afford monthly and what your other financial goals are besides owning a home.
