Today, we’re looking at the value of term reduction on a mortgage loan. Term (length of the loan) reductions can be a great vehicle to accomplish two goals:
- Pay off the loan more quickly
- Reduce the total cost of interest over the life of the loan
In general, the mortgage interest rate goes lower as the term of the loan is made shorter. The 15 Year will nearly always carry a lower rate than the 30 Year.
The 20 Year is odd. Sometimes it is virtually identical to the 30 Year, sometimes it will be as much as .25% lower. These numbers look at the total cost of the mortgage (cumulative interest paid) over two-year intervals from closing until the 10th year. Years 21-30 are very heavily weighted in favor of the 20 Year Fixed since that homeowner no longer is making payments.
Based on yesterday’s rates, the comparison would look like this:
| 30 Year | 20 Year | ||
| Interest Rate | 4.750% | 4.500% | |
| Loan Amount | $200,000.00 | $200,000.00 | |
| Total Monthly Payment | $1,043.29 | $1,265.30 | |
| Total Cost of Mortgage (by year) | 30 Year | 20 Year | Savings |
| 0 | $0.00 | $0.00 | $0 |
| 2 | $18,717 | $17,452 | $1,265 |
| 4 | $36,805 | $33,689 | $3,116 |
| 6 | $54,202 | $48,599 | $5,603 |
| 8 | $70,839 | $62,056 | $8,783 |
| 10 | $86,640 | $73,924 | $12,717 |
Closing costs are no higher, no lower for the 20 Year Fixed. As such, at the time of closing, the loans are identical. It is over time that the value of the 20 Year begins to appear.
Here is a look at the total savings over the first 10 years:
As you can imagine, the real savings are just kicking in when we finish our graph to the right.
Is the 20 Year right for everyone? Probably not. However, with rates so low, many former 30 Year Fixed borrowers are able to stomach the 20 Year Fixed payment with just a slight increase to payment.
Tags: FHA Loan Rate, FHA Mortgage Refinance