The 30-year mortgage remains the most popular among homebuyers, as consumers opt for the lower monthly payments they provide. A 15-year mortgage reaches the end of its repayment terms quicker but has higher monthly payments. There’s a third, less-discussed option for homebuyers who want a compromise between those two extremes. A 20-year mortgage may not be the first thing your lender mentions, but it’s definitely worth asking about it.
TL;DR (Too Long; Didn't Read)
You can get a 20-year mortgage, usually for a lower interest rate than a 30-year mortgage, but you may have to shop around to find lenders that offer it.
Getting a 20-Year Mortgage
You may not realize it until you start looking for one, but a 20-year mortgage is widely offered. Bank of America offers fixed-rate mortgages in 15-, 20- and 30-year increments, as do a host of corporate, online and local lenders. If you have a specific lender in mind, ask if 20-year mortgages are an option even if they don’t advertise it on their website. Since 30- and 15-year mortgages get all the attention, they may simply not put the information online.
With a 20-year mortgage, you’ll have one rate that will remain the same throughout the 20 years that the loan is in effect. Often, those who opt for a 20-year mortgage are drawn to the low monthly payments, but they’re not happy with the amount of extra interest they’ll pay over the term of the loan. This gap is even bigger when interest rates are high. At a 4 percent interest rate, you’ll pay nearly 2.2 times more over the life of a 30-year mortgage than you would have if you’d taken out a 15-year mortgage. A 20-year mortgage shrinks that gap a little without pushing your monthly payment as high as it would have been if you’d gone with a 15-year mortgage.
Fixed vs. Adjustable-Rate Mortgages
If you aren’t happy with the 20-year mortgage rates you see, an adjustable-rate mortgage may be an option to consider. The most popular type is the 5/1 ARM. It offers a fixed rate for the first five years of the loan, which is the “5” in 5/1. At the end of the five-year period, your interest rate can change every year, which is the “1” in the equation. Most ARMs follow the index, which is the rate set by the market. It can be unpredictable, especially over a 20- or 30-year period.
The 5/1 ARM isn’t the only option. Some lenders offer 3/1, 7/1 and 10/1 ARMs. Since the average homebuyer stays in his home 10 years, the 10/1 ARM could be a viable option. As long as you sell before or not long after the 10-year timeline is up, you’ll pay the original interest rate throughout your time there. The 10/1 ARM is especially appealing since homebuyers can sometimes get a deal on interest rates by choosing an ARM versus a fixed-rate mortgage.
20-Year vs. 30-Year Mortgage
Generally, the biggest advantage of a 20-year mortgage is the interest rate. When compared to a 30-year mortgage, you’ll usually find that the 20-year rate is lower. Although it changes from one day to the next, the rate for a 30-year mortgage is currently 4.69 percent, while the 20-year rate is only 4.28 percent. You can get an even lower interest rate by going with a 15-year mortgage, which has an interest rate of 4.04 percent.
When you crunch the numbers on mortgage costs for your dream home, you can easily see the difference in monthly payments among a 15-, 20- and 30-year mortgage. Although 20-year mortgage rates will be lower than committing to 30 years, you’ll also pay much less in interest over the course of that 20 years. This may make the slightly higher monthly payment worth it.
Mortgage Paydown Methods
Instead of a 15- or 20-year mortgage, some homebuyers choose a different approach. They take out a 30-year mortgage, committing to a lower payment, but they put as much extra toward the principal as they can throughout the year. One way to do this is to simply write a big check once a year that helps lower the amount you owe on the house outside of the interest you’re paying. So, if you owe $200,000 on your house, and you mail a $1,000 check in December, you’ll owe $199,000 in January, giving you a jump on the amount you’ll be able to pay your mortgage down in the coming year with your normal payments. The one check a year option usually works best for those who get a work bonus or a big income tax refund every year.
You can also pay down your mortgage quickly in small ways that add up. One option is to simply add a little extra to your mortgage payment each month. That could be $100 or $50, but whatever it is, it starts to knock out that principal. Some lenders will allow you to pay every two weeks rather than once a month, so it might be worth checking into that since it results in one full extra payment each year. It’s important to note, though, that paying extra doesn’t in any way allow you to skip a payment or reduce your monthly payment. You’ll have to refinance to change your payment due amount. Even if 20-yr. mortgage rates are lower, having a 30-year mortgage and paying it down quickly can save you more in the long run.
Calculating Your Mortgage
If you’re looking for a house, or you’re simply considering the possibility of buying one sometime soon, it’s important to know exactly how much you can afford. Lenders go by the 36 percent rule, which measures your debt in relation to your income. That means if you have an annual salary of $56,516, your monthly house payment should be no more than $1,695. However, what the lender recommends is not the same as what you personally can afford, so it’s important to be honest about your own finances. There are calculators available online that will tell you what you can expect to pay based on your down payment, the home you hope to buy and the interest rate at the time your lender locks you in at a rate.
Look for a calculator that will include information on your nonhousing-related expenses, such as groceries, entertainment, alimony or child support, your car payment and your credit card payments. You’ll need to look at what you can realistically afford before you start house hunting. This will help you as you speak to real estate agents and complete a mortgage application to get preapproved.
Qualifying for a Mortgage
You may think the first time you’ll fill out a mortgage application is when you’ve found a house. You can save time for everyone if you put in an application before you even start looking. This is called getting preapproved, and it lets both real estate agents and sellers know that when you place a contract on a property, the deal won’t fall through due to your application being declined.
However, before you can even fill out a mortgage application, you need to make sure you’ll get approved. You can do this by making sure your credit score and debt-to-income ratio are both in good shape when you walk into the lending institution. If you’re getting an FHA loan, you’ll need a credit score of at least 580. It can possibly go as low as 500 if you’re able to put down 10 percent. Conventional loans will require an even higher credit score, ideally 620 or above. It may be that you have to delay buying a house while you work on improving your credit and paying down your debts.
- Freddie Mac: Why the 30-year Fixed Rate Wins "Most Popular"
- Bank of America: Fixed-Rate Mortgage & Rates
- Bankrate: Compare Top Mortgage Rates for November 2018
- Zillow: What Is a 20-Year Fixed Mortgage?
- Investopedia: The 30-Year and 15-Year Mortgages: A Comparison
- Bankrate: Adjustable-Rate Mortgages: Learn the Basics of ARMs
- The Mortgage Reports: Homebuyer Tenure: How Long Are People Staying In Their Houses?
- Bankrate: 10/1 ARM
- Zillow: Today's Average 30-Year Fixed Rates
- Interest.com: 3 Free Ways to Pay Your Mortgage Faster
- NerdWallet: How Much House Can I Afford?
- Bankrate: How Much House Can I Afford?
- NerdWallet: How to Get a Mortgage
Stephanie Faris has written about finance for entrepreneurs and marketing firms since 2013. She spent nearly a year as a ghostwriter for a credit card processing service and has ghostwritten about finance for numerous marketing firms and entrepreneurs. Her work has appeared on The Motley Fool, MoneyGeek, Ecommerce Insiders, GoBankingRates, and ThriveBy30.