Key Takeaways
- Shorter terms save money on interest over the loan's life.
- Longer terms mean lower monthly payments but more interest paid.
- 15-year loans build equity faster, leading to quicker ownership.
- 30-year loans are popular for first-time buyers needing affordability.
Article Summary
Loan term is the number of months or years a home buyer's mortgage loan lasts.
Loan Term: Explained in Plain English
A mortgage loan term is the period, expressed in months or years, over which a home buyer must pay back their mortgage's original principal balance plus interest.
USDA mortgages are all 30-year loan terms, but most other mortgage types let home buyers and refinancing households choose their mortgage's term.
The three most common mortgage loan terms are:
- 360 months / 30 years
- 240 months / 20 years
- 180 months / 15 years
Other loan terms, including 25-year and 10-year, are sometimes available depending on the loan type.
A mortgage's loan term affects its mortgage rate, monthly payment, and the pace at which the home builds equity. Loans with shorter terms have a higher PITI and pay down faster. Conversely, loan with longer terms are more affordable monthly but take longer for the buyer to own their home free-and-clear.
The majority of first-time home buyers choose a 30-year loan term. Since 2018, conventional mortgage rates have averaged 41 basis points higher for 30-year loan terms compared to 15-year terms.
Common Loan Terms and Market Share (Purchase Mortgages, 2018-2024)
| Loan Term (Months) | Market Share |
|---|---|
| 120 | 0.24% |
| 180 | 3.06% |
| 240 | 1.07% |
| 360 | 92.99% |
| Other | 2.64% |
Loan Term: A Real World Example
Imagine a first-time home buyer choosing between a 15-year and 30-year mortgage loan term for an upcoming purchase.
The 15-year term looks attractive because the buyer will build home equity and own the home faster. However, because the mortgage payback is compressed into half as many years, monthly payments are larger and reduce the home buyer's housing budget.
After careful consideration, they decide that choosing a 30-year mortgage is the more prudent path, offering lower monthly payments, a boost in purchasing power, and the ability to send optional extra payments to pay down their balance at any time in the future.
Common Questions About Loan Terms
Get answers to frequently asked questions about loan terms, including how they affect payments, interest rates, and when to consider different options.
How does a mortgage loan term affect its monthly payments?
Shorter mortgage loan terms typically result in higher monthly payments, with less mortgage interest paid over the life of the loan. Longer mortgage loan terms typically result in lower monthly payments and more mortgage interest paid.
Can you change your loan term after closing on a mortgage?
Once a mortgage is closed, the loan term is generally fixed. However, refinancing can change the loan term, but this involves taking out a new mortgage.
Is a shorter loan term better?
Shorter loan terms save money for home buyers but may be more challenging because shorter loan terms mean higher monthly payments. If the mortgage payments for a shorter loan term cannot be managed, a buyer could default and lose the home to foreclosure.
How does loan term affect interest rates?
Generally, mortgages with shorter loan terms come with lower interest rates. Lenders offer lower rates for shorter terms because the loans have less perceived risk to the bank.
What happens if I pay off my mortgage before the loan term ends?
Making extra payments to pay off a mortgage early reduces a mortgage interest costs. However, in rare cases, a loan may have a prepayment penalty, so it is important to check with the lender first.
