A 30 Year Mortgage is by far the most popular term (length) of mortgage within the United States and most of the world, and for several reasons. Not only are they historically the "go-to" option for most lenders, but 30 years seems to offer the "sweet spot" that offers maximum benefit to home buyer and financier alike.
How does a 30 Year Mortgage Work?
Basically, a 30 year mortgage means that after 30 years, you won't have any more payments and your house will legally be yours, i.e.: The bank or lending institution hands you the note.
That's the short version. Here's a longer one:
When you take out any loan, regardless of what it is for, you'll be looking at three basic variable:
- Loan Amount: The total amount that the lender will pay the lendee up front. In the case of a mortgage, this is usually the price of the home minus any down payments.
- Loan Term: How long the lendee has to pay off the lender. The longer the term, the lower the payments.
- Interest Rate: How much the lender will add to the overall mortgage amount every year. The lower the interest rate, the less the value "pushes" up.
On a traditional 30-year mortgage, the term is established up front as, well, 30 years. That means that the monthly payments are based on the loan amount and interest rate. The lower these are, the lower your payments become for the next three decades, and vica versa.
30 Year Mortgage Calculator
Want to know what your payments will look like for a fixed-rate 30-year mortgage before signing the bottom line? All you need is a basic spreadsheet program (like Microsoft Excel) and some elementary knowledge of setting up math equations.
If spreadsheets aren't your thing, there are several free mortgage calculators available on the Internet. But a quick word of caution when using them: Almost all of them are ran by mortgage brokers, so it's likely that they plan on collecting your information for leads purposes. I suppose there's nothing wrong with that, but I just wanted you to be aware.
Why Will I Pay Three Times The Value Of My House Over 30 Years?
One word: Interest.
Your home loan lender will tack interest onto your unpaid balance every month, based on the mortgage interest rate. Initially, your minimum payments will barely cover the cost of the interest, leaving your mortgage principle virtually untouched. But each payment you make gradually brings that principle down, reducing the effects of added interest. Eventually the principle will get low enough that the added interest barely adds up to anything - of course you'll suffer through the first 10 or 12 years feeling like you're not even making a dent to get there.
Making only the minimum payments, and given recent interest rates, by the time you pay off your 30 year mortgage, you'll have actually payed more than three times the original value of the mortgage to your bank or lending company.
Sounds crazy, huh? But that's just the way the lending business works. Remember, they have to make money, just like you.
Why A 30 Year Mortgage Is Better Than A 15 Year Mortgage
Many mortgage brokers offer a 15 year mortgage version, and admittedly it has one very nice selling point: Your house will be paid off in half the time.
Of course it comes with a very big offsetting variable: Your payments will be about double.
But even if you have the money/income for a 15 year mortgage, there's still one big advantage of a 30 year version: A lower minimum payment. That comes in really handy during down times or emergencies when you might not have the funds for a 15 year payment. But remember, a "monthly minimum payment" is just that, a minimum. You can pay more than the minimum if you want! So what makes sense to me is to sign up for a 30 year mortgage, then make payments greater than the minimum requirements.
Assuming you make the same payments as you would for the shorter term version, you'll still pay it off in that amount of time. But it gives you the safety margin for financial emergencies.
Early Payoff Penalties On 30 Year Mortgages
The scenario I mentioned above works wonders, and many banks have noticed. And since the banks make their money off the interest, they often take steps to recoup some of their virtual losses in these instances.
The result: Early Payoff Penalties
Here's how they work: If you pay off the balance of your mortgage before the term expires, the lender will sock you with a hefty fee. It's just their way of making money. Personally, I avoid any kind of loan with these stipulations like the plaque.
Using 30 Year Mortgages For Refinancing
Refinancing a home mortgage has almost become standard practice amongst home owners, as many people refinance their balances as soon as it makes financial sense to do so. Almost any lender will offer a refinance home mortgage option, which basically just means they'll offer you a new loan to replace your existing one. Or more specifically, they'll give you a new mortgage that pays off your old one.
Just remember that any early payoff penalties will still apply to your original mortgage!
When Should You Refinance?
Generally speaking, any time you can find a mortgage vehicle that works better with your current financial plan is a great time to refinance. One of the most common reasons why people refinance is because the mortgage interest rate drops far enough below their current rate that the change over would mean cheaper monthly payments. Some people find that the value of their house is greater than their mortgage principle (i.e. they have equity), and refinance their homes with a new mortgage that reflects the new value, thus giving them the difference between the mortgage principle and the home value in cold hard cash.
There are any number of reasons that could make a refinance (or "refi") right for you. But it all depends on your current situation and financial goals.
But even with a refinance, I still stand by the "safety net" method of opting for a 30 year mortgage.