Which Mortgage Term Is Best?

The word “term” is not always clearly understood when it applies to a mortgage.

Mortgages come with “terms and conditions,” along with other legal mortgage terminology that's important to understand.

A mortgage term specifically relates to the number of payments and amount of time it takes to repay the loan. Many people are familiar with a 30-year mortgage, but that's only one kind of term. 

Different situations often work better with different mortgage terms. For instance, a major donation toward your home purchase — accompanied with a gift letter — might enable you to shorten the mortgage payoff period to 25, 20 or fewer years.

How Mortgage Terms Are Best Used

Raw land mortgages vary considerably, and the terms will usually vary depending on the planned final use of the land.

For example, a loan for a new home construction may begin as a short-term loan of two or three years. When home construction is complete, these are often converted to 30-year loans.

Raw land mortgages typically require a major down payment as high as 50%. Down payment assistance might be needed, and will require a gift letter.

Refinancing can be a good opportunity to reduce the number of years remaining on your loan. It depends on the amount of equity value you’ve accumulated in your home.

You gain equity as you pay down the loan and as the value appreciates. If you refinance for something like a remodel, you don’t have to pull all of your equity out of your house.

The remodeling can be paid for from the appreciated value, and your new loan can actually be for a smaller amount than the original loan. With a smaller loan, you can refinance for 20 years or less instead of for another 30 years.

Many times and situations call for changing your mortgage term. Adjustable rate mortgages, or ARMs, can offer an attractive beginning interest rate.

A good time to refinance is when the interest rate increases above the 30-year fixed rate. But instead of a 30-year fixed rate, you often obtain a lower interest rate with a shorter term 15- or 20-year fixed rate loan.

Balloon Payments Have Unique Terms

A balloon mortgage is a unique hybrid in which the mortgage doesn't fully amortize over the loan term.

For instance, a five-year balloon payment loan can have monthly payments that appear as if it were a 30-year loan — but the full outstanding balance comes due at the end of five years.

Most people will need to refinance the loan when the balloon payment comes due. Again, give some thought about the best mortgage term when taking out the new loan. A shorter 10-, 15- or 20-year term may be more appropriate than a longer 30-year loan.

Balloon mortgages can have many variables. One possibility is an interest-only loan.

In that case, your monthly payment will be lower, but none of the principal will have been reduced when the balloon payment comes due.

You may still need financial assistance qualifying for a new loan. This is another time that a financial gift accompanied by a gift letter may be needed.

Mortgages are offered with different terms for good reasons. Just because a 30-year term is most common doesn’t mean it is the best mortgage term for your specific needs.