The shorter the mortgage term the larger the monthly payments, so for most people a five-year fixed mortgage amounts to a bigger payment than they can afford. Under the right circumstances, however, a five-year fixed can be an excellent product that brings very favorable interest rates with it.
TL;DR (Too Long; Didn't Read)
A five-year fixed mortgage comes with the downside of a large monthly payment, but you save with a lower interest rate and lower life-of-loan costs.
Fixed-Rate Mortgage Basics
One of the best things about fixed-rate mortgages is that you can count on your interest rate. Borrowers of variable-rate, or adjustable-rate, mortgages – also known as ARMs – are vulnerable to potential increases in rates. The downside to a fixed-rate product is that if market rates drop, your rate still remains the same.
Larger Monthly Payments
Monthly payments with a five-year mortgage are larger than for the same loan amount spread out over a longer period of time. If you had a loan for $150,000 at 5 percent, each monthly payment would be about $2,830. The same loan spread out over a 15-year term would have monthly payments of $1,186, and over a 30-year term you’d pay just $805 each month.
The big question is whether or not you can really afford that larger payment. The lender will require that you have a higher income in order to qualify to make larger payments.
Lower Interest Rates
When it comes to mortgages, the lowest rates usually come for the shortest loan terms. This is probably the single best thing about a five-year mortgage. The difference could be 1 percent or more for a five-year as compared to a 15- or 30-year product. It’s a matter of simple math: the lower your interest rate, the less you pay in the end.
Lower Life-of-Loan Costs
Over the life of the loan, the savings for a five-year loan are great. That $150,000 mortgage at five percent would cost you a total of $289,883 in principal and interest if you took 30 years to pay it. That’s nearly double the original home cost. Paid over 15 years the total cost would add up to $213,514 If you paid it off in five years, the total cost would be $169,841, not that much more than the original loan amount.
Who Should Get One
For anyone who can afford to make the higher monthly payments, a five-year fixed mortgage is an excellent option. Refinancing to a shorter term is a great option for someone who’s been in a house a few years already. Shorter mortgages are also a good product for someone who is a conservative investor and would prefer to pay off his home rather than to use the extra cash toward other investments.
Who Should Not Get One
Many people argue that if you can secure a low rate mortgage, you’re better off with a longer term that will free up more money every month to invest elsewhere. A disciplined investor who will actually follow through with the alternative investing plan may be able to rationalize this strategy, but if you’re prone to temptation and might just spend the extra money on foolish things, you’re better off paying the mortgage down. Few investments come with any guarantees, but you can count on the lower mortgage interest rate that comes with a shorter term.
Annabella Gualdoni has written newsletters and reports for corporations and nonprofits since 1994. She is a real estate professional and also teaches subjects including international cooking and travel, dating/relationships and personal finance. Gualdoni has a Bachelor of Arts in international development from University of California, Berkeley, a Master of Arts in international relations from Boston University, and a Juris Doctor from Boston College Law School.