What are loan terms when you buy a house? A loan term refers to the number of years it will take to repay a home loan. Loan terms play a significant role in determining your monthly payment cost and your lifetime loan cost. Terms and conditions are elements advised to review in your closing disclosure and we will review them both here.
Repayment Period
This is the primary term of a loan agreement. The most common mortgage is the standard 30-year conventional mortgage. This option is popular because the long repayment period allows smaller monthly payments.
Another common option is the 15-year loan. Loan terms are flexible and can range from 5-30+ years. The benefit of a shorter loan term is that you’ll be able to pay a home off sooner and you can land lower interest rates than 30-year loans.Â
Second time buyers using money from a previous home sale can make a shorter term mortgage easier as profits can be used as a large down payment, making monthly payments lower.
However, even first-time buyers can qualify for 15-year mortgages if they have the income to make larger payments.
Comparison of 30-year and 15-year mortgage
Here’s an example of how loan terms significantly change the loan cost on the lifetime of a home loan- to the tune of $200k!
- 30 year, $300k conventional loan:
- Interest rate: 6%
- Monthly payment: $1,799
- Total loan cost: $647,515
- Total interest: $347,515
- 15 year, $300k conventional loan:
- Interest rate: 5.8%
- Monthly payment: $2,499
- Total loan cost: $449,869
- Total interest: $149,869
Work with your lender and evaluate your income, lifestyle, debt-to-income, and future financial expectations to determine if the cost savings of a shorter loan term are worth the higher monthly payment.
Amortization table
Your mortgage’s amortization table is a schedule that lists monthly payments from the time you begin repayment until the day it’s paid off. Your personal amortization schedule will detail how much of each payment will go toward your interest or principal as the life of the loan progresses.
Why is it necessary? Your monthly payments aren’t determined just by cutting your loan up into 15 or 30 years of payments. As your loan payments progress, the portions you’re paying toward principal and interest actually vary.Â
While your actual payment amount remains the same each month, the portions devoted to principal and interest fluctuate. Loans start with higher percentages of your payments going toward the principal. That flips as you get closer to paying your loan off.
Interest Rate
Your interest rate plays a major role in determining monthly payments. However, your interest rate is technically considered a condition of your loan instead of a “term.” When selecting a home loan, the two main options for homebuyers are fixed-rate mortgages or adjustable-rate mortgages (ARM).
With a fixed-rate mortgage, you’re agreeing to a single interest rate that will apply for the life of the loan unless you choose to refinance for a lower rate.
With an ARM, you’ll start at an introductory rate that can either go up or down based on overall interest rates. The three main choices with arms are:
- 5/1 ARMs: Fixed rate for five years before adjusting annually.
- 3/1 ARMs: Fixed rate for three years before adjusting annually.
- 10/6 month ARMs: Fixed rate for 120 months before adjusting every six months.
Interest Rate vs. APR: What’s the Difference?
When shopping for interest rates to buy a home, don’t confuse your interest rate for your APR. The interest rate advertised by a lender won’t be the same as your loan’s actual annual percentage rate (APR). Your interest rate only represents the annual cost to the borrower expressed as a percentage.
While APR is also expressed as a percentage, it’s a more comprehensive number because it includes all other charges and fees that can include private mortgage insurance (PMI), discount points, origination fees, prepaid interest, and closing costs.
Fees
Like interest, fees are actually conditions of a loan instead of terms. Fees can be unique to a borrower based on the details of the loan they’ve worked out with the lender. Common loan fees include:
- Origination fee: Upfront, one-time fees charged by lenders for processing the application, underwriting, and funding a mortgage.
- Buydown/mortgage points: Borrowers can get lower interest rates by purchasing prepaid mortgage points at closing. Generally, one discount point totaling 1% of a loan amount can bring the interest rate down by 0.25%. There are permanent and temporary buy downs.
- Closing costs: Typically represent 3% to 6% of a loan amount.
- Late fee: The penalty charged when a monthly mortgage payment is made after the due date. Most lenders charge 3% to 6% of the monthly amount owed.
- Early payoff fee: Penalty fee charged by lenders to discourage borrowers from paying off their mortgages early. When mortgages are paid off ahead of schedule, lenders don’t get to collect their planned interest. Some lenders may allow you to make extra payments as long as they don’t exceed a certain percentage of your loan balance for the year.
