The first thing that the length of the mortgage affects is the size of the repayments that need to be made
Why is the length of the mortgage important?
January 27th, 2010
The length of a mortgage is often one of the last things that people think of when buying a house. However it is one of the most important things for a home buyer to consider.
The first thing that the length of the mortgage affects is the size of the repayments that need to be made. As in most mortgages the principal that the lender advanced needs to be paid off over the term of the loan, the amount of each repayment goes down. The repayments do not decrease quite in proportion to the length of the repayment term due to the effect of interest, but the difference is substantial. To some people a long term is needed simply because it makes a home affordable. However the length of the repayment should not be lengthened simply to make repayments smaller, as the total cost increases.
The cost increases because the total interest payments are much larger over a long term loan. A normal mortgage over twenty five years will have the borrower paying as much in interest as they are paying for the house itself. As interest is charged over the loan then the total interest paid increases in proportion to the length of the loan and so the interest over the whole term of the loan can increase dramatically with a longer term loan.
Due to the higher total interest paid over a longer term loan; the interest rate can actually be lower, further reducing repayments. This is because a lender is likely to make higher profits from the life of the loan, and so are willing to reduce the price.
A cost that also increases over the length of the loan is the holding or administrative fees that are charged either quarterly or monthly. Although these fees are a small proportion of the mortgage repayments they can increase the total cost of the mortgage quite substantially. For example a $15 monthly fee over ten years will mean that there is a $1,800 holding fee that is paid over that period.
Another factor that should be considered is retirement. There are few decisions that affect retirement that need the attention of a person in their twenties or thirties, apart from the decision to take out a pension in the first place. However taking out a loan for a house does involve this calculation. A 36 year old buying a house which they expect to raise their family will be 61 when a 25 year mortgage has been paid off, but 66 when a 30 year mortgage has been paid off.
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