Choosing the Right Term of Your Home Loan Could Save you Thousands

January 23, 2017

Choosing the Right Term of Your Home Loan Could Save you Thousands

Did you realise that you could save thousands to tens of thousands on your mortgage simply based on the duration of your loan? In general, borrowers focus on the interest rate and the fixed interest vs. variable term to get the best possible deal on a mortgage. However, the length of the loan is actually a significant factor in determining the overall cost of your loan, sometimes even more so than the actual interest rate.

The Difference Your Mortgage Term Can Make

It is a simple concept; the longer the term of your loan, the more interest that you will pay. While a shorter term is generally associated with larger monthly mortgage repayments, when you look at the sizable difference in what you will pay in interest over the entire life of the loan, the larger monthly repayments may be worth considering.

Take for example a $400,000 mortgage at an interest rate of 4.25%:

  • A 30-yr term would end up costing $308,393 in interest.
  • A 25-yr term would end up costing $250,086 in interest.

That’s a saving of $58,307 if you opt for a 25-yr mortgage!

  • With a 30-yr term, your monthly repayments would be $1968.
  • With a 25-yr term, your monthly repayments would be $2167.

If you could afford paying about $200 more each month in your mortgage payments, then you could pay back your loan in less time and save nearly $60,000 in interest.

Despite this reality, longer terms have become increasingly popular in Australia. According to industry expert Peter Arnold, with higher home prices and bigger mortgages, lengthier terms are being used to help more borrowers afford to purchase a home in the first place. These longer terms are a symptom of the size of mortgages and the way people can afford a bigger home loan.

Refinancing the Smart Way

Homeowners usually refinance every three to five years in order to save money by getting a better rate. You could reduce your monthly repayments if you can refinance at a lower interest rate but you may end up paying more overall if you extend your term.

This is an important and very costly factor to keep in mind when shopping around for lenders. In some cases, a lender will only offer refinancing options at 25, 30 years, or even 40 years. Refinancing for a longer term will extend your loan and increase your overall interest payments, even if it lowers your monthly repayments.

If you have already paid down a reasonable portion of your mortgage, then you may be able to afford the higher monthly payments that would come from selecting a shorter loan term which would save you from paying more in interest over the life of your loan. In this case you may not reduce your monthly repayments that much if at all but you would lower the overall cost of your mortgage.

This is why it is important to think about what is right for your financial situation, both in the short and long-term. Also, take your time comparing the offers that different lenders are presenting and ask your current lender about the options that they may be willing to give you if you refinance with them.

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