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Mortgage Rate vs. Mortgage Term

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Homeowners who are shopping for a home mortgage usually put finding a loan with a relatively low mortgage loan rate as a priority. A large number of factors come into play in determining the interest rate associated with a particular loan, including the type of loan (fixed, adjustable, hybrid, other), the loan-to-value ratio, the amount of the loan, the homeowner's credit rating, the homeowner's debt-to-income ratio, and the length of the mortgage.

For many years, the standard length of a mortgage was 30 years, or 360 months. With the proliferation of different types of mortgage loans as the market became more sophisticated and as the competition increased among mortgage lenders to offer loans that are attractive to homeowners, mortgage loans with term lengths other than 30 years appeared. Loans with a repayment length of 15 years (180 months) are quite common, but mortgage loan terms of 10 or 20 years are also available. Since a loan with a shorter repayment term, or maturity, involves less risk to the lender, this type of loan carries a lower mortgage loan rate than does a 30-year home loan. On the other hand, a mortgage with a term of 30 years requires that the lender carry the balance for a much longer time period, which is riskier for the lender, so a higher mortgage loan rate is charged in this case.

Many homeowners like the idea of being able to completely pay off their home mortgage more quickly to retire their mortgage debt, and they also like the idea of the lower mortgage loan rate associated with shorter-term mortgages. However, there is a downside to these loans: since the loan principal amount is amortized over a much shorter time period than it is with a 30-year loan, the monthly payments on a shorter-term loan are higher.

If a homeowner can afford the higher monthly loan payments associated with a mortgage with a shorter term, they will reap benefits in paying off their mortgage sooner and in saving thousands of dollars of interest that they would pay with a standard 30-year mortgage. The savings in interest paid is two-fold: part of the savings is due to the lower mortgage loan rate associated with any shorter-term mortgage, and the other part of the savings is associated with avoiding the interest which would be paid during the additional months of a 30-year mortgage payment schedule.