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Everything You Need to Know About 30-Year Fixed-Rate Mortgages

Everything You Need to Know About 30-Year Fixed-Rate Mortgages

When you’re shopping for a home, there’s more to consider beyond the number of bedrooms, size of the yard and the location. You also need to think about how you’ll pay for the house. For many homebuyers, that means applying for a mortgage.

Not all mortgages are created equally. Some offer a fixed interest rate, which remains the same throughout the life of the loan. Others have adjustable rates, which can change based on a schedule. Some mortgages need to be paid off within 15 years, and others give you 30 years to pay. A 30-year fixed-rate mortgage is the most popular option among homebuyers. Learn more about what it means to take out a 30-year home loan and whether it’s the right option for you.

What Is a 30-Year Fixed-Rate Mortgage?

A 30-year fixed-rate mortgage is a home loan with a repayment term of 30 years and an interest rate that remains the same throughout the life of the loan. When you decide to take out a 30-year home loan with a fixed rate, the payment you owe each month is the same until you’ve finished paying the loan. If your first month’s payment is $1,000, your 12th month’s payment will be $1,000, your 36th month’s payment will be $1,000 and so on. If the interest was 5% during the first year of the loan, it would be 5% in year two, year six, year 15 and year 29.

What Is the Average 30-Year Fixed Mortgage Rate?

Many factors influence mortgage interest rates. The average interest rate has risen and fallen over the years as a result of market conditions and other factors. For example, in 1980, the average interest rate on a 30-year home loan was 13.74%. In 2000, it was 8.05%. In 2019, the annual average interest rate was 3.94%.

Some of the factors that affect mortgage interest rates are outside of the control of the average person. Supply and demand have an effect on rates, for example. When there is a lot of demand for mortgages, interest rates usually increase. When demand is low, rates drop to make getting a mortgage more appealing to consumers.

There are a few factors that influence interest rates that homebuyers can control. The amount of other debt you have can influence your interest rate. If you have a lot of debt already, a lender might consider you a higher risk compared to someone with less debt. To compensate for the additional risk, they are likely to offer a higher interest rate.

Your credit history and score also influence the interest rate on a 30-year mortgage. Usually, the higher your score, the lower your interest rate. If you don’t have favorable credit at the moment, it can be a good idea to work on improving it before you apply for a home loan.

Finally, how much you put down upfront can also affect your interest rate. The bigger your down payment, the less of a risk you seem to lenders. In exchange, they are likely to give you a lower interest rate compared to a person who is making a smaller down payment.

Can You Pay off a 30-Year Mortgage Early?

Thirty years seems like a long time. If you buy a house when you’re 35-years-old and get a 30-year mortgage, your last payment will be scheduled for right around the time you reach the retirement age of 65. One thing worth knowing about a 30-year mortgage is that just because you can take 30 years to pay it off doesn’t mean you are obligated to do so. Many lenders may let you pay off your loan early. Some do charge a pre-payment or early payment penalty. Before you pay extra on your mortgage, double-check to confirm that your lender won’t penalize you for doing so.

If you are interested in paying off your mortgage early, there are multiple ways to do so. If you get paid biweekly, you can try making biweekly payments on your mortgage, instead of monthly. Divide your monthly payment in half and pay one half when you get your first paycheck of the month and the second when you get paid the second time. Since there are 26 biweekly pay periods in a year, you’ll end up paying 13 months’ worth of your mortgage, rather than 12.

Another option is to add on an additional amount when you schedule your monthly payment. Even paying an extra $100 or $200 per month consistently can shave years off your mortgage.

How Does a 30-Year Fixed-Rate Mortgage Work?

When you apply and are approved for a 30-year fixed-rate mortgage, two things are certain. Your interest rate will not change and your mortgage will be broken down into a series of payments over the course of 30 years. The payments include interest and principal together and remain the same throughout the loan.

Many homeowners also pay their property tax and homeowner’s insurance premiums with their mortgage payments. If you put down less than 20% of the price of the home, you will also have to pay private mortgage insurance (PMI) premiums until you’ve paid off enough of the principal to equal 20% of the home’s value.

Principal and Interest

The mortgage principal is the amount you’ve borrowed to pay for your home. If you buy a $250,000 home, pay a 20% down payment of $50,000 and borrow $200,000, the $200,000 is the loan’s principal. As you make payments on your mortgage, the principal shrinks.

Interest is the fee charged by your lender for giving you the loan. One way to look at it is the cost of doing business with a particular lender. Just as you might pay a lawyer or a doctor a fee for their services, you pay your lender for their services in the form of interest.

The cost of getting a loan can vary considerably from person to person because of interest. One borrower might be offered a 5% rate on a $200,000 loan, while another borrower might be offered a 3% rate.

Since interest is a percentage of the loan amount, it tends to be higher at the beginning of your repayment period than it is in the end. For example, when you first start making payments on your $200,000 home loan, you are paying 5% interest on $200,000. As you chip away at the principal, it shrinks and so does the interest in proportion.

Although you start out paying more interest than principal on your mortgage and eventually begin paying more toward the principal and less in interest, the payment you are required to make each month remain the same due to something called amortization.

Amortization Schedule

Loan amortization is the process of paying off your debt over a defined period with fixed payments. When a mortgage is amortized, the principal and interest are combined. It differs from other types of mortgage payment schedules because you pay the same amount and know what you need to pay from month to month.

An example of a mortgage that does not amortize is a balloon mortgage. If you were to agree to a balloon mortgage, you make small payments each month for a set amount of time. Often, the payments would only cover the interest due on the loan. At the end of the repayment period, the remaining balance is due in full.

In addition to mortgages, other types of installment loans, such as car loans and student loans, typically get amortized.

When you close on your house and finalize the 30-year fixed-rate mortgage, your lender can provide you with an amortization schedule. The schedule breaks down each payment over the life of the loan and details how much goes toward the interest on the loan and how much goes toward the principal. It also lists the ending balance on the loan at the end of each payment period, so you can keep track of your mortgage as you pay it off. You’ll also find the total amount of interest paid on the amortization schedule. The total interest gives you an idea of how much your mortgage will cost you over time.

Who Needs a 30-Year Fixed Mortgage?

Although 30-year fixed-rate mortgages are the most popular option for homebuyers, they are far from the only choice available. Some mortgages have adjustable interest rates, for instance. Adjustable-rate mortgages (ARMs) offer an introductory rate for a set period, such as five years. At the end of the introductory period, the rate changes based on the market. It can decrease if rates have dropped or increase if they have spiked. Although an ARM can offer you a lower rate than a fixed-rate mortgage at the start, there is the risk that your rate may increase later on, and with it, your monthly payment.

Thirty years is also not the only term available for a home loan. Some loans have 15-year terms. Less common are 10-year, 20-year or 25-year mortgages. The longer the mortgage term, the smaller the monthly payments are as you have more time to pay the loan. A person who might struggle to make payments on a $200,000, 15-year loan might find they are comfortable making payments on a $200,000 30-year loan.

A 30-year fixed-rate mortgage can be the right option for you if:

    • You live in an area with expensive housing:A 30-year home loan can put buying a home within reach, even in areas where the price of housing is high. Another way of thinking about it is that you can get more house for your money if you get a 30-year mortgage instead of a 15-year loan.
    • You want a predictable payment schedule:Your mortgage payment can be predictable if you get a 30-year fixed-rate home loan. The interest and principal payment stay the same for the entire repayment period.
    • You want a lower monthly payment:Since you are going to take twice as long to pay down the loan, the monthly payment on a 30-year loan is usually considerably lower than the payment due on a 15-year mortgage, even if the principal balance is the same. Paying less toward housing each month can mean you have more money to put toward other financial goals, such as saving for retirement or for your children’s education.
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Pros of a 30-Year Fixed-Rate Mortgage

For many borrowers, the pros of a 30-year fixed-rate mortgage make it worthwhile:

  • It offers flexibility:When you take out a 30-year fixed-rate mortgage, you can stick to the amortization schedule provided by your lender or you can choose to pay extra on the loan, reducing your debt and speeding up the process of owning your home outright. For example, you may decide to pay several hundred dollars more than you owe each month when you have the space in your budget to do so. But if your expenses increase or your income drops, you have the option of paying what’s due on the loan and holding off on making extra payments.
  • It allows you to buy “more house”:You can often afford to buy a more expensive home with a 30-year mortgage compared to a 15-year loan, depending on your income. If you live in an area with high housing costs, a 30-year mortgage can make it easier to buy a home that meets your family’s needs.
  • It can create space in your budget:Since the monthly payment on a 30-year mortgage is often lower than the payment due on a 15-year loan, it can give you some wiggle room in your budget. You can use any additional income you have to pay down your home loan more quickly, or you can choose to save it for a rainy day or for another financial goal.

  • It’s available to more borrowers:Depending on your income and other financial circumstances, you might find it easier to qualify for a 30-year mortgage compared to other options. Since the monthly payments are lower for a 30-year compared to a 15-year mortgage, you can qualify for a 30-year loan with a lower income.
  • It is more likely to qualify you for a tax deduction:You can deduct the interest you pay on your mortgage from your income each year, but it’s not always the most appropriate option. For itemizing your deductions to make sense, the amount needs to be more than the standard deduction. In 2020, the standard deduction is $12,400 for single tax filers and $24,800 for married couples who file a joint return. Since you often pay more interest on a 30-year mortgage during the early years of repayment, it can make you more likely to save on your tax bill.
  • It eliminates surprises: A 30-year fixed-rate mortgage can be an ideal option for people who like predictability. You know what your payments are, so you can create a dependable budget. You don’t have to worry about costs increasing year after year, so it can eliminate some stress from your life.

Cons of a 30-Year Fixed-Rate Mortgage

A 30-year fixed-rate mortgage does have some drawbacks that are important to think about:

  • You’ll pay more in interest: Over the course of 30 years, you are likely to pay considerably more in interest on your mortgage than you would on a loan with a shorter term. For example, if you borrowed $160,000 with a 3.37% interest rate, you would pay $94,726.03 in interest over the 30 years. If you borrowed the same amount with the same interest rate for 15 years, you would pay $44,086.16 in interest over 15 years.
  • Interest rates are usually higher: You don’t just end up paying more interest over the life of your home loan when you have a 30-year mortgage. You might also have to pay a higher interest rate. Lenders consider risk when they set interest rates. A 15-year mortgage is typically considered lower risk to a lender, as the term is shorter and there is less of a chance of a borrower defaulting. While 30-year mortgages are very common, they are also considered higher-risk and usually have somewhat higher interest rates.
  • Thirty years is a long time: Another thing to consider before applying for a 30-year mortgage is that 30 years is a relatively long time. It’s difficult to envision what your life will be like at the end of your mortgage term. One thing to remember is just because your mortgage will be paid off in 30 years, it doesn’t mean you need to keep the loan for that long. If you can afford to pay extra toward the mortgage, you are free to do so. You can also sell your home before the 30 years is up and use the proceeds from the sale to pay off the mortgage.
  • It will take longer to build up equity in your home: Your home’s equity is the difference between the value of your home and the amount you owe on the mortgage. When you take out a mortgage with a shorter term, you pay down the principal relatively quickly, building up more equity in your home. With a 30 year loan, it takes longer to chip away at the principal, meaning you have less equity. The longer it takes to build up equity, the greater the chance you may end up upside-down on the mortgage if the market takes a hit. When you’re upside-down, you owe more on the home loan than the house is worth.

  • It can be harder to put 20% down:You might qualify for a bigger loan with a 30-year term compared to a 15-year term. But it can also be more challenging to come up with a sizable down payment when you’re buying a more expensive house. For example, you’ll need $40,000 to put 20% down on a $200,000 house. The amount jumps to $60,000 for a $300,000 house. Not having 20% to put down doesn’t mean you can’t buy a house. It simply means you’ll have to pay PMI and you may not get the best possible interest rate.
  • You might buy more home than you’re comfortable with: Another thing to consider when getting a 30-year mortgage is that you might end up buying more house than you can take care of or manage. Bigger houses tend to have higher upkeep costs. They also tend to require more care and attention compared to smaller, less expensive homes. For example, if you buy a home with a large yard, someone will need to take care of the yard.

Apply for a 30-Year Fixed-Rate Mortgage With Abby

If a 30-year mortgage with a fixed rate seems like a good option for you, applying for the home loan can be simple thanks to Abby, the online mortgage application assistant from Assurance Financial. Abby can walk you through the application process in 15 minutes, helping you take the first steps toward homeownership. Get started on your application today or schedule an appointment with a loan officer at a time that works for you.

 

Sources

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