Numbers on buying a place: Picking a mortgage term

There are way too many loan term options to choose from!

  • Fixed rate: 40 year, 30 year, 20 year, 15 year, 10 year
  • Conforming 30 year Adjustable Rate Mortgage (ARM): 1 year, 3 year, 5 year, 7 year, 10 year
  • Conforming 40 year ARM: 3 year, 5 year, 7 year, 10 year

At my credit union, it looks like the rate for the 15 year fixed rate and the 7/1 year ARM conforming 30 year are the same rate, but the required payments on the 15 year fixed rate are about double the required payments on the 7/1 year ARM.

It looks like I could comfortably pay off the mortgage in 7 years, with upping my investment amount from 20% of my gross income to 28% of my gross income. (I had planned on upping how much of my gross income I invest once I finished saving for a down payment.)

The total interest paid over the course of loan is $6,000 more on the 30 year loan paid off in 7 years versus the 15 year or 7/1 ARM paid off in 7 years.

I think that a 40 year loan is unnecessary and the 1, 3, and 5 year ARM rates are not ideal since paying off the mortgage in 5 years would be far too aggressive. The 10 year ARM rate is the same as the 20 year fixed rate, so I would prefer to go with the 20 year fixed mortgage.

This narrows my options down to:

  1. 30 year fixed rate
  2. 20 year fixed rate
  3. 15 year fixed rate
  4. 10 year fixed rate
  5. Conforming 7/1 ARM 30 year

In order for my required monthly fixed expenses to not exceed what they are now, I can’t spend more than $1,000 per month in P&I (principal and interest), which limits me to a 30 year fixed rate or the Conforming 7/1 ARM amortized over 30 years. If I’m willing to go over by $200, the 20 year fixed rate would work. Monthly P&I on the 15 and 10 year fixed rates is way too high.

My final options are:

  1. 30 year fixed rate
  2. 20 year fixed rate
  3. Conforming 7/1 ARM amortized over 30 years

The catch on the last one is that  if the rates go up in 7 years, then I would want to have the loan paid off by that point, whereas the first two offer more flexibility. Perhaps the 20 year fixed rate is the best compromise then. It would result in my fixed costs going up about $200 per month and would only cost about $3,500 more in interest over the course of the loan if paid off in full in 7 years.

This still looks like a tough decision – there are far too many options!

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