Choosing your mortgage term isn’t one of the things that immediately comes to mind when first thinking of a mortgage, but it’s a decision with a huge implication on your finances for many years, so getting it right is important.
Rather than just opting for the standard twenty-five year mortgage term, take a moment to consider other options.
Mortgage term, not fixed rate term
Most banks will allow borrowers to choose between a fixed rate term or a variable rate mortgage. A fixed term mortgage is one that comes with a number of years at a fixed rate of interest; typically one, three or five. While choosing an appropriate fixed-rate deal is a very important part of your mortgage process, it’s not what we mean by ‘mortgage term’ in this article.
Mortgage term is the entire length of your mortgage, not just the ‘fixed rate’ part.
|For more information about fixed rate and variable mortgages, why not read our article here?|
The two basic mortgage term factors
There are two key financial factors that dominate the short-term vs. long-term mortgage argument:
Interest on the loan
Though it has its own name, and many detailed nuances, a mortgage is just a loan like any other, and the core of it works in a very simple way. You borrow a sum of money, each month interest is calculated on the loan, and each month you pay some back.
Because with a mortgage you are borrowing a large amount of money, even the slightest change in interest rates can have a profound effect – the same is true when you stretch the length of the term.
When you are looking at the difference between a 20-year mortgage or a 25-year one, you are looking at five years of extra interest. The complexities of calculating compound interest on the decreasing balance of a repayment mortgage means it isn’t always completely easy to work out the difference, so we have an example:
AED 1,000,000 over 25 years at 4% would generate AED 583,511 in interest.
AED 1,000,000 over 20 years at 4% would generate AED 454,353 in interest.
The shorter term loan would save AED 129,158 in total interest paid.
Of course, this calculation is over-simplified; there has been no change in interest rate over the years, and both loans are set to the same interest rate whereas in reality, your 25-year option may have a different rate to your 20-year option, but it serves to illustrate the simple truth: if your loan term is longer, you will generally pay more in interest.
If the interest accrued is strongly in favour of a shorter-term mortgage, then monthly budgeting shows to be equally stronger in favour of a longer-term one.
By spreading the loan over more years, you make each monthly repayment smaller. This can be easily demonstrated by imagining a small AED 1,000 interest-free loan paid back on different terms. Over ten payments, each would be AED 100; over five payments, each would be AED 200; and repaying it in three payments would make each one AED 333.33.
Expanded over the length of your mortgage, this simple principle works identically:
AED 1,000,000 over 25 years at 4% would require a monthly repayment of AED 5278.37
AED 1,000,000 over 20 years at 4% would require a monthly repayment of AED 6059.80
The longer-term loan works out at AED 781.43 per month cheaper to pay back.
If your affordability on your loan is a factor, then you are more likely to be approved for a longer term mortgage.
Additional factors in favour of short-term mortgages
There are other reasons why a short-term mortgage may be more appropriate:
Mortgage providers have a cap, often to age 65 or 70, by which time your mortgage must be paid off in full. This has recently seen some changes leading to more flexibility, you can read more here, but the core truth remains: If you are older than 45, then you may not be in a position to easily secure a 25-year mortgage. In these cases, a shorter-term mortgage is available for you to purchase your home.
If your mortgage size is smaller, it makes sense to pay it off sooner. The difference in monthly payments between a 15, 20 and 25-year loan will be decreased, and clearing the debt sooner is beneficial.
New, competitive rates
Mortgage lenders have a number of impressive fixed-rate deals. You can speak to us about the current offers in the market.
The joy of being mortgage free
Obviously, if you pay your mortgage earlier, you reach that position of 100% ownership sooner. Living mortgage free is an aim for every homeowner, why not bring the date forward if you can?
On the side of long-term mortgages
A short-term loan is not right for everyone; here are some of the benefits with long-term mortgages:
Deals that compete with the short-term market
As the major advantage to a short-term deal is the drop in overall interest paid, long-term lenders often offer impressive interest rates on their long-term deals to mitigate the difference. Discuss the options with us to find out what’s available for you.
Future rental plans
If you plan to return home, or purchase another property in the future, then the lower monthly cost of a long-term mortgage makes it a far superior deal when looking at becoming a landlord and renting out your home. With short-term mortgages, it is harder to cover the entire monthly outgoing with an incoming rent payment.
Dealing with the unknown
Should your circumstances change for the better, switching to a shorter-term loan is far from impossible, with many lenders willing to make the alteration. Going from a short-term to a long-term loan because your situation has taken a downturn and you want to lower the monthly repayments is much more difficult. A long-term mortgage is a lot easier on you in periods of difficulty.
Overpayments – the best of both worlds
With overpayments, it is possible to make your long-term mortgage seem like a short-term one. Many mortgages, especially longer-term ones, allow for fee-free overpayments, giving you the flexibility to cut months off your mortgage term when your circumstances are good and cash flow is not an issue. Discuss a mortgage with fee-free overpayments with us when you are making your initial application.
Getting the right length mortgage with Mortgage Finder
Long-term or short; we can help you make the decision. Contact us at Mortgage Finder and we can help you analye your finances and your options to get you a deal to fit your personal circumstance. Give us a call or fill in our contact form today.