When choosing how to finance your home, less is more! As you pick out your mortgage, you soon find that selecting a 10 over 30-year loan can typically save you time and money. We say typically because no one’s homeowner plan is exactly the same.
Just like there are many different types of mortgage, all with different rates and terms, there are so many different types of homeowners as well. Everyone has a different budget, different priorities, and a different plan for how long they plan to stay in a house.
To ensure you can make the most-informed personal choice on the best type of real estate loan for you, we’re here to explain each type of mortgage rate and plan.
Here’s what you need to know:
What is an adjustable-rate mortgage?
Sometimes, we call an adjustable-rate mortgage an ARM for short. An ARM is a type of mortgage loan where the interest rate on the total balance can change (i.e. it is adjustable) as long as the account is still open. Usually, the interest rate is fixed for certain periods of time. This means that it doesn’t change every single day, but rather changes only periodically, like monthly or yearly.
There are always two numbers when examining or listing an ARM. The first number is always how many years the fixed rate will apply to the mortgage, while the meaning of the second number varies from loan to loan.
Here are a few examples:
If you see a “2/28 ARM” or a “3/27 ARM” as home loan options, then you will automatically know that each loan has a fixed rate for two years and three years, respectively. However, looking at the second numbers, you will then know that each number then has a changing rate as well. In this case, the length of the changing rate will be 28 and 27 years. Add these together and you arrive at the typical 30-year mortgage length.
If you see a 5/1 ARM, this means that the mortgage has a fixed rate for the first five years of its life, followed by a rate that changes every single year (as we can tell by the one) for the rest of the life of the loan. A 10/1 ARM is another popular option, just with a longer initial fixed period.
To avoid drastic, unmanageable interest rate changes, ARMs often come with something called rate caps. Rate caps limit how much the interest rate can change in one specific moment. Periodic rate caps limit the rate change from year to year, while a lifetime rate cap limit the overall interest increase over the entire life of the loan.
If you would like to apply for an adjustable rate mortgage, then you should work with your lender to use a mortgage calculator to cycle through all the different scenarios. This way, based on your personal budget and how long you actually plan to stay in a home, you can be sure to pick the option that is best for you financially and logistically.
What is a fixed-rate mortgage?
A fixed-rate mortgage is another popular loan option for buyers who prefer a little bit more stability in their budget. There is still a little bit of a risk for a fixed-rate mortgage, however. This is because you take a risk when you lock in your interest rate when you first get your loan. You have to hope that a better one won’t come along down the line, or you would have to refinance your loan to obtain it.
When interest rates are low in general, it’s more of a risk for the lender to give out a fixed rate mortgage. This is because there is a possibility that the rates will rise soon and by locking in a low rate, the lender can miss out on a larger repayment opportunity via interest. However, as a borrower, this is great news because you won’t have to lose so much money to interest over the course of your loan’s life.
If you plan to pick a fixed-rate mortgage, make sure your credit score is high and market rates in general are low. This way, you can get the best rate possible and can save yourself from having to go through an expensive and time-consuming refinancing process later on down the line.
What is a 10-year mortgage?
The average term for a mortgage is about 15 to 30 years, so a 10-year mortgage is a pretty accelerated payment option. Even so, there are still two very different types of ten-year loans to choose from should you want to go this route. The best choice for you also heavily depends on your personal goals and finances.
Here are the two choices for 10-year mortgages.
- A 10/1 ARM with a 30-year term.
- 10-year fixed rate mortgage.
As explained, the 10/1 ARM has a solid interest rate for the first 10 years and then after that time period, it can change annually for the next 20 years. But, with a 10-year fixed rate mortgage, you pay the same amount each month (including a standard interest rate) and then, after 10 years, BOOM. You build equity in your home at lightning speed and are finished with your mortgage in record time.
How do I know if a 10-year mortgage is right for me?
Whether or not you choose a 10-year mortgage all depends on the size of your credit and your cash flow.
This is because the monthly payments on a 10-year mortgage are obviously going to be pretty large, as you only have 120 months to pay it off. But, because of the overall shorter loan term, your savings on interest are going to be massive as well.
To find out by just how much, use a mortgage calculator to find out the terms of 120-month loan vs. a more standard 360-month loan. Your jaw just might drop at the difference.
But therein lies the issue. In order to save lots of money with a 10-year mortgage in the long term, you have to have lots of cash on hand right now.
Can you give me an example?
Let’s say you take out a $250,000 mortgage loan. If it is a 10-year fixed mortgage with an interest rate of 3%, you will pay $2,414.02 a month. This is a pretty steep payment plan, but, if you are currently renting in a major American city, it could be comparable with what you are currently paying each month.
(Although, realistically, you would not be able to buy a home in an area where just the rent is that high for this price. You would need to move pretty far out into the suburbs.)
Now, let’s compare that with a monthly payment of only $1,787.21 if you had a 15-year fixed at 3.5%, and a payment of $1,193.54 if you have a 30-year fixed at 4%. As you can see, the amount for the 10-year loan is nearly twice the size of the 30-year option.
That’s just not a realistic option for many homeowners. It’s not a good idea for someone who needs to make a low down payment or even a first time homebuyer who might not have a lot of savings yet. It’s also difficult to get FHA loans or VA mortgages for these terms.
This is why, at least as far as 10-year mortgages go, the first “hybrid” option is bit more popular. This is because it’s basically just a 30-year loan with an initial 10-year fixed period. Once the first ten years of predictability are over, the rates can swing either higher or lower, depending on the prevailing market trends at the time.
Although, just like when you take out a fixed-rate mortgage, it’s a bit of a gamble because you can never know for sure what the new rates are going to be like.
What is a 30-year mortgage?
Much like their 10-year counterparts, 30-year mortgages come in many different shapes and sizes as well
30-year Fixed-Rate Mortgage
For this type of mortgage loan, you lock in an interest rate at closing and can expect to pay pretty much the same amount of money each month for the entirety of the loan’s term. This is a great option for homeowners who plan to stay living in one house for a very long time, possibly even for the entire term of the loan.
Loans like this are also a good option for buyers who need to stay on a budget. This is because monthly payments are often low and predictable, so it’s easy to plan ahead for each month, as well as the long-term.
However, as with any situation, there are still cons. You will end up paying back a lot more than you originally borrowed for the house. This is because of the many years that the interest can build up on top of the loan.
For example, if you take out a $160,000 home loan with a pretty average interest rate of just 7%, you’ll end up paying $223,217.48 in JUST interest by the end of the 30 years. When you add the principal amount back in, it comes to a total of $383,217.48 paid. It’s a bit shocking to see the difference laid out like this.
However, this is why many homeowners choose to refinance their mortgage when they live in a home for a long period of time. This is especially true if their finances or credit scores improve, so they can score a better interest rate and make bigger monthly payments to burn off some of the excess interest.
A Quick Note for Investors
While most investors choose to purchase homes flat out in cash, if you do take out a mortgage to finance an investment property, there are terms you need to make sure that you know.
Here is the most important one to keep track of:
Balloon Payment Mortgage
This type of mortgage usually only happens for commercial real estate and not residential real estate. So, if you buy a business, strip center, or other commercial property, you might run into a balloon payment.
A balloon payment is a tricky kind of financing in which the balance doesn’t actually become fully amortized over the entirety of the loan’s term. Sometimes this is because it was an interest only loan at the beginning. Regardless, at the end of the loan’s time, you will have a large balance due.
Those in the industry call this amount a balloon payment because of its size and how it swells up over time.