Typical quotes for mortgages are for 15 years or 30 years (180 months or 360 months). You can literally select any time period up to 360 months and get a quote from the mortgage lender. The factors that will influence your decision to select a particular time period over the other are:
Your age
If you are buying (or refinancing) a house after your age 45 then a 30-year mortgage will take you to monthly payments up to your age of 75 years. This is usually a red flag you would need to set for yourself as you are likely to retire at the age of 65 and your source of steady income will stop at that age. Unless your loan amount is very small, or you can have backup money to either pay the monthly installments or you plan to sell your house and pay the loan you can go with a 30-year mortgage plan. Otherwise, I would recommend you consider shortening the mortgage payback period to (say) 240 months. Note that when you reduce the period, your monthly EMI may increase significantly.
Interest Rates Yield Curves
When you are in the process of financing your home for the first time, you are left with no choice but to shop the best interest rates available from various lenders. Usually, the best to worst lenders would be in the ballpark of the ongoing rates and may differ by about 0.5% in their quotes. The lending rates are usually a function of the prime lending rate or the bank rate and the future expectation of the movement of rates. Although no one can predict the future events that will impact the rates, there is a constant change that you can see in these rates due to several people like you financing their homes. These rates get determined by market dynamics and is used by lenders. We typically call the future rate movement expectations yield curves.
Interest rates quoted for a lower tenure of the loan are usually lower compared to higher tenure. This may not always be the case. Another key factor that would determine your rates will be if you are okay to switch to a variable rate (market driven) after a period of 5 or 7 years on a 30-year mortgage. These rates are usually the most attractive even compared to a 15-year fixed rate mortgage because after the 5- or 7-year period, the risk of interest rate fluctuation get transferred to you and does not remain with the bank.
Mortgage rates are usually the lowest form of loan (compare it to personal loans, auto loans or business loans). This is because, the bank owns your home till the time you pay off your mortgage. Your home is the security that your lender uses to extend you a credit. Usually homes are appreciating assets (unlike a car which depreciates the more you use it) and the loan amount can be recovered by the lender in case the buyer defaults. That is the reason the bank will ask that their exposure be limited to maximum 80% of the home value (and they will expect you to make a 20% down payment). So even if the property value falls by 20% the lender can recover their money by selling the home.
Higher the interest rates, more is the mortgage payment and lower the rate, lesser is the payment. For a $400,000 loan, every 0.125% reduction in interest rate, your mortgage payment will reduce by $25 if the tenure of your loan remains the same.
Monthly Outgo
This is an extremely important parameter that you would need to consider when taking a mortgage. You need to do a thorough homework before you commit. Understand that when you take a mortgage, you will commit to paying the lender an equal amount of money every month throughout the tenure of the mortgage. You need to list down all your income sources and reduce all mandatory expenses. Think of all the life events that may have a material impact to your payment capacity (like kids’ education, foreign trips, car purchase, home remodeling). Determine the amount of money that you are willing to put aside to service the loan. Do not get aggressive when going for a lower tenure which will increase your monthly outgo. You can always for a higher tenure for your loan and have lower monthly payments and decide to pay lump sum pre-payments (which will directly go towards reducing your outstanding principal and thereby reduce your loan tenure). You can also pay more than your monthly EMI payments each month and stop this extra payment when your income reduces, or expenses increases.
Also note that if you have made aggressive payments for you loan and you need money for an unexpected financial event then you will not be able to withdraw from the loan. You are left only with an option of refinancing which will come with a cost. You are the best judge to keep the fine balance between your loan servicing and your contingency fund.
