Amortization is defined as the monthly payment including principal and interest required to pay off a loan in a specific period of time. When choosing a home mortgage, it is obvious that the required monthly payment will be higher to pay off a loan in fifteen years than it will be over thirty years but there are other considerations.
Many of the standard fixed rate mortgage programs offer long term amortization up to forty years and as short as 10 years on conventional mortgages. By far the most popular options with consumers are the thirty and fifteen amortized mortgages. Fifteen year loans offer the obvious advantages of an early pay off and a substantially reduced amount of interest paid out during the term of the loan. The additional advantage is the interest rate is usually somewhat lower with a fifteen year mortgage. The variance is generally per percent to per percent depending upon current market conditions. Forty year amortization seems like a good idea for keeping the payment low but in execution it does not provide much of a payment advantage over the thirty year. The objective is additionally compromised because the interest rate can be slightly higher than the thirty year mortgage, negating some of the monthly payment savings. Shorter payment terms such as twenty-five and twenty years do not normally provide an interest rate advantage over the thirty year term rendering them “functionally obsolete” although there may be exceptions based on the consumer's commitment to a long term plan.
Fifteen year amortized mortgages have great advantages over thirty year terms; shorter term pay off, lower interest rate and rapid equity build up. There is one glaring problem with them as an option for most home buyers. Because of the shorter term, the monthly payment is significantly higher than that of the thirty year amortization; so much so that the fifteen year payment is out of reach for most home buyers. The fifteen year loan is best suited for those with upward employment mobility who are buying well below their means or those refinancing a home with substantial equity or significant cash reserves.
Consideration should be given to possible unforeseen financial setbacks causing the monthly payment on the fifteen year mortgage to become a serious burden. In such events, the only recourse is an expensive refinance to a thirty year amortized mortgage which only works if the borrower's qualifications have not been compromised by the negative events. If the objective of the fifteen year term is to realize an early pay off or to build equity at a faster rate, there are other alternatives. Standard mortgages today have no prepayment penalty. In other words, any payment in addition to the required monthly payment is allocated to the principal loan balance. The result is an early payoff and lower amount of interest paid over the life of the loan. Many home buyers make their mortgage payment twice each month.
For example one half of the mortgage payment is paid before it is due on the fifteenth of the preceding month and the other half on the first of the month when the entire payment is due reduces the pay off term from thirty years to twenty-two years . The mortgagee is not paying more, just making half of the payment early. Interest is only charged on the mortgage balance so in effect paying early reduces the interest accrual; therefore, shorting the pay off term. In addition, one supplementary mortgage payment per year (sometimes at tax refund time) further reduces the amortization to eighteen years. Most loan servicers will readily accommodate this arrangement. The effect of this strategy is that it can accomplish nearly the same equity and pay off result as the fifteen year amortized mortgage without the high monthly payment obligation.
The consensus is inflation and supply and demand factors work in contradiction to low property values and are likely to push property values higher in the near future. The fifteen year mortgage is a practical strategy for those in a stable living and employment environment. Fifteen years is not very long over a lifetime and the equity in a home with no mortgage can contribute to a very comfortable retirement.