Mortgage loan term: What is it, and which option is best for you?

Whether you’re a first-time home buyer or a seasoned pro looking for your forever home, you may understandably find yourself confused with all the jargon surrounding the mortgage loan process. One word that’s prone to cause confusion for borrowers is “loan term,” because it can be used to refer to one or multiple aspects of a mortgage.

So, what is a loan term and why is choosing the right loan term length an important part of the home buying process? Let’s take a closer look.

Loan term definition

“Loan term” is defined most narrowly as the duration of a loan, or the total amount of time it will take a borrower to pay off the loan when making their regularly scheduled payments. When you take out a mortgage, you and your lender will agree on the length of the repayment period.

Your loan term will not only determine how long you have to pay off your loan, it’ll impact your monthly payment amount and the total amount of interest you pay over the life of the loan.

Types of mortgage loan term lengths

Mortgage loans are available in various term lengths, allowing borrowers to choose the option that’s best for them. Loan terms can be broadly broken down into two categories: short-term mortgages and long-term mortgages.

Short-term mortgage loans

A home loan with a term of less than 10 years is typically considered a short-term mortgage. Short-term mortgage loans are favorable because they allow homeowners to pay off their home loans in less time.

However, because the loan balance is split over fewer months, the payments on short-term loans are significantly higher than they would be for the same loan amount spread over a longer term.

Long-term mortgage loans

Long-term mortgages are a popular option because they make homeownership more affordable for the average buyer. There are various long-term loan terms, with 15- and 30-year mortgages being popular among home buyers.

With a long-term mortgage loan, the loan amount is paid over a longer period of time, resulting in lower monthly installments. The downside to a long-term mortgage is that you’ll end up paying more interest since you’ll be making more payments over the life of the loan.

What determines a mortgage loan term?

The term length available to you will depend on what your lender offers as well as individual borrower requirements. To determine the loan term you qualify for, your lender will examine your credit score, debt-to-income (DTI) ratio and other factors.

Why is loan term length important?

As mentioned, your loan term length will impact the amount you pay each month and the amount of interest you ultimately pay over the life of the loan. This is perhaps best illustrated by a mortgage amortization schedule, which reveals the exact amount you’ll pay each month on your mortgage and includes how much of each payment goes toward the loan principal and interest. It will also show how your total loan balance decreases over time and the amount of interest you’ll end up paying throughout the loan term.

Before you take out a home loan, it may be a good idea to play around with a mortgage amortization calculator to ensure you have a thorough understanding of how your loan will work.

Term length comparison example

The chart below breaks down the monthly mortgage payments and total interest costs for the same loan amount over different loan term lengths. We used a loan amount of $200,000 with an interest rate of 6%.

In this example, a 30-year loan term offers the lowest monthly payment amount at $1,199.10. This offers a monthly savings of $488.61 versus the 15-year loan term. However, you’d pay $127,888 more in interest over the life of the loan by choosing a 30-year mortgage over a 15-year mortgage.

Additional mortgage loan terms and conditions

We’ve established that “loan term” commonly refers to the length of time it will take to repay a loan in full. However, any other condition to which a lender and borrower agree can also be considered a loan term.

In fact, “loan terms” is often the umbrella verbiage used to describe the various terms in your mortgage agreement, which may include:

• Annual percentage rate (APR): APR is a figure that combines your annual interest rate and any additional fees that your lender may charge over the life of the loan.
• Closing costs: Your closing costs are processing fees that you pay your lender in order to close on your home loan.
• Additional fees: Additional fees included in your loan terms may include origination fees, application fees, annual fees, prepayment penalties and late payment fees.
• Payment due date: The day of the month that your loan payment is due will be outlined in your loan terms.

Negotiating your loan terms

With a thorough understanding of your loan term length and the other associated terms and conditions, you may be able to negotiate with your lender and arrive at more favorable terms. You can also get a mortgage preapproval with different lenders, which will allow you to see the terms that different lenders offer. With multiple options, you can confidently choose the right option for your situation.

The bottom line

In the strictest sense, “loan term” refers to the length of time it takes to repay a loan in full when following the scheduled monthly mortgage payments. But “loan term” may also be used more loosely to describe another condition – such as APR or closing costs – associated with your mortgage.

Before you take out a mortgage, it’s important to have a good understanding of the proposed loan term length and how it will affect your monthly payment amount and the total you’ll pay over the life of the loan. If you have any questions about your loan term length or other loan terms, be sure to get clarification from your lender before signing your closing documents.

If you’re ready to begin the home buying process, the Home Loan Experts at Rocket Mortgage^® can help. Get your initial approval online today.