Choosing Among Fixed-Rate Mortgages

While all ARMs have terms of 30-years, the term on FRMs varies from 10 years to 40 years. The term is the period used to calculate the mortgage payment. The shorter the term, the lower the interest rate, and the faster the borrower pays off the loan. But shorter-term FRMs also have higher monthly payments, which may be unaffordable to the borrower.

A good decision rule for those who have decided on an FRM is to take the shortest term their budget can handle without undue strain.

The 30-year and 15-year FRMs are priced the best because they have the largest secondary markets, and they are the most popular among borrowers. The price of the 15 is always well below, but the payment is always well above that of the 30. The price of the 20 is between that of the 15 and the 30, but closer to the 30, while the 40 is priced significantly higher than the 30. Before the financial crisis, the 10 was priced about the same as the 15 or only slightly lower, but in 2011 the spread had become significant.

The selection process should start with the 10 or 15 because they are the best dealsaround for borrowers who can afford the payment. Most of those who can't afford the 10 or 15 opt for the 30 because the payment is substantially lower. The 20-year term is for borrowers who want to pay off as soon as possible but can't quite make the payment on the 15.

If you are uncertain, comparing the rates and payments at different terms may help you make a decision. You can use Monthly Payment Calculator (7a) for this purpose.

Some borrowers who can make the payment on a 15 are persuaded to take a 30, or even a 40, in order to invest the difference in cash flow. I don't recommend this because making it pay requires a very high investment return. See Can You End Up Richer Taking a Longer Term?

Additional Reading: Fixed Rate Mortgages (FRMs)

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