Selecting Mortgage Terms

The term of a mortgage is the period used to calculate the mortgage payment. It should be distinguished from the maturity, which is the period until the final payment is due. On most mortgages they are the same, but on some the maturity is shorter. This is true of balloon mortgages, for example, where the term is usually 30 years but the borrower must make a final "balloon" payment in 5 or 7 years.

The longer the term, the lower the mortgage payment but the slower the borrower builds equity. Borrowers who want to make their payments as small as possible select the longest term available. The reduction in payment from lengthening the term, however, becomes less and less effective as the term gets longer. This is illustrated in the table below, which shows the mortgage payment on a $100,000 loan at various interest rates and terms.

Mortgage Payment Per $100,000 of Loan Amount:
Term	6.00%	6.25%	6.50%	6.75%	7.00%	7.25%	7.50%
5 Years	$1933	$1945	$1957	$1968	$1980	$1992	$2004
10 Years	1110	1121	1135	1148	1161	1174	1187
15 Years	844	857	871	885	899	913	927
20 Years	716	731	746	760	775	790	806
25 Years	644	660	675	691	707	723	739
30 Years	600	616	632	649	665	682	699
40 Years	550	568	585	603	621	640	658
Int Only	500	521	542	563	583	604	625

For example, at 6% extending the term from 10 years to 20 years reduces the payment by $394 but extending it to 30 years and 40 years reduces the payment by only $116 and $50, respectively. The furthest you can possibly go in extending the term is to infinity, which is an interest-only loan -- you never repay any part of the loan. On a 6% loan, the monthly interest is $500, just $50 less than the payment at 40 years.

Extending the term to reduce the payment also becomes less effective at higher interest rates. For example, at 6% extending the term from 20 to 30 years reduces the payment by $116 but at 12% the reduction is only $72. Where the interest payment at 6% is $50 less than the payment at 40 years, at 12% the interest payment is only $8 less than the payment at 40 years.

Borrowers who want to build equity in their home as quickly as possible select the shortest term they can afford. As illustrated in the table below, the shorter the term, the more rapid the increase in equity. For example, after 10 years the borrower with a 15-year term at 7% has repaid 54.6% of the original balance whereas the borrower with a 30-year term at the same rate has repaid only 14.2% of the balance. Since 15-year loans usually carry a lower rate than 30-year loans, this understates the difference in the rate of equity buildup.

Percent of Loan Balance Repaid After Specified Periods at 7%
Term	After 5 Years	After 10 Years	After 15 Years	After 20 Years	After 25 Years	After 30 Years	After 40 Years
5 Years	100.0%	100%	100%	100%	100%	100%	100%
10 Years	41.4%	100%	100%	100%	100%	100%	100%
15 Years	22.6%	54.6%	100%	100%	100%	100%	100%
20 Years	13.7%	33.2%	60.8%	100%	100%	100%	100%
25 Years	8.8%	21.4%	39.1%	64.3%	100%	100%	100%
30 Years	5.9%	14.2%	26.0%	42.7%	66.4%	100%	100%
40 Years	2.7%	6.6%	12.1%	19.8%	30.9%	46.5%	100.0

There is one situation where an equity-building borrower who can afford the payment on a shorter term might select a longer term. A borrower with attractive investment opportunities, such as a family business or the stock market, might select a longer term and invest the mortgage payment savings in high-yield investments. Since the rate on longer term loans is usually higher than the rate on shorter- term loans, however, the borrower must stay with the longer term loan long enough for the high earnings on the savings in the payment to offset the loss from the higher mortgage rate.

The tables below show how long you must stay with a 7% 30-year mortgage to come out ahead of a shorter-term mortgage carrying a lower rate when the difference in payment is invested to earn a return higher than 7%. For example, if you can invest current cash flow to earn 12%, and your alternative to a 7% 30-year loan is a 15-year loan at 6.75%, you will come out ahead if you stay more than 41 months.

Number of Months to Break Even in Selecting a 30-Year 7% Mortgage Over Shorter-Term Mortgages Carrying Lower Rates

Rate on Short-term Mortgage 6.75%:
Shorter Term Loan	8% Return on Savings	10% Return on Savings	12% Return on Savings	14% Return on Savings	16% Return on Savings
10 Years	75 months	31 Months	20 Months	15 Months	12 Months
15 Years	144	63	41	30	24
20 Years	274	124	81	61	49
25 Years	None	296	204	156	126
Rate on Short-term Mortgage 6.875%:
Shorter Term Loan	8% Return on Savings	10% Return on Savings	12% Return on Savings	14% Return on Savings	16% Return on Savings
10 Years	44 Months	17 Months	11 Months	9 Months	7 Months
15 Years	87	34	22	16	13
20 Years	166	69	44	32	26
25 Years	None	165	109	81	65