How to Choose the right Term for a Home Mortgage

The right term for a home mortgage depends on the stability of your finances, your family situation, your expectations of future interest rates, and your tolerance for risk. Mortgage terms and penalties for early withdrawal may also be relevant if you suspect you may be selling your house before you pay off the balance of your mortgage.

1-year term

Nearly all 1-year mortgages are balloon mortgages, where a substantial amount of the balance is due or refinanced at the end of the term. This balance is theoretically calculated based on the expected resale value of the home, but in the current real estate market, that estimate may be out of step with current market prices. The effect is the same as a teaser rate. In general, 1-year terms should be avoided except as bridging loans until the sale of a previous home or other financial windfall.

5-year term

This term is available in both fixed and variable interest options. In rare cases, the entire cost of the house can be financed over 5 years. However, it is much more usual to calculate the payments on a 5-year mortgage as if it were amortized over a 25- or 30-year term, leaving a large balloon payment to be paid or refinanced at the end of the mortgage term.

Interest rates for 5-year mortgage terms are usually lower than for longer terms. Some 5-year mortgages offer a teaser rate for the first year, after which the interest rate jumps by 1% or more. This will result in a sudden rise in the mortgage payment after the teaser rate expires. A 5-year term also offers no interest security beyond the fairly short term of the mortgage.

If future plans are not completely stable over the short term, this term can offer the best combination of flexibility with some degree of security. In this case, interest rates must be weighed against early payment penalties. If you expect the mortgage interest rate to drop further or if you expect to sell your house in about 5 years or so, this mortgage term offers flexibility without locking you in for the long term.

15-year term

The term offers a bit of flexibility without compromising long-term mortgage payment security. A 15-year fixed rate mortgage will usually be at a slightly higher interest rate than mortgages with shorter terms or variable rates, but your mortgage payment will not change over the entire term of the mortgage. This term may be particularly suitable for families with young children, where parents may want a lifestyle change after their children go to college or move away from home.

30-year term

This term offers the best predictability. After you are locked in, neither interest rate changes nor inflation will affect your costs. A 30-year fixed rate mortgage will usually be at a slightly higher interest rate than mortgages with shorter terms or variable rates, but your mortgage payment will not change until your house is completely paid off at the end of 30 years. If you prefer to avoid interest rate volatility and want security over the full term of your mortgage, then a 30-year fixed rate mortgage is the way to go.

On the other hand, if interest rates drop, you will not be able to take advantage of that drop without refinancing at steep penalties. It is usually wise to avoid refinancing unless your situation will continue to be stable for at least 18 months and the new interest rate is at least 2% lower than what you are currently paying. In general, these are the minimum conditions under which all fees related to refinancing will be less than the amount of interest you will save under the new interest rate.