Should you get a long or short term mortgage?
A ‘term’ means the length of time you spread your loan repayments over. When people are looking for a mortgage, many don’t realise there are other options than the ‘standard’ 25 year term. In fact, very often this is the ‘go to’ term for many mortgage providers when discussing options with potential customers.
While for many borrowers a 25 year term is suitable because it allows them to pay off their mortgage before retirement and sets the monthly contractual payment to an affordable amount, you can often choose whatever term you want. These days, you can choose a term of 30 years or more to help you to find payments that fit within your monthly budget.
The choice of term you make should be strongly influenced by affordability. In order to get a mortgage approved you’ll need to ‘fit’ within the mortgage lender’s affordability requirements. But just as importantly, you also need to be comfortable that you can afford the payments now and in the future. If you can afford to pay a bit more each month, it’s worth comparing mortgage terms maybe 25, 20, and even 15, years.
Length of mortgage term versus the size of the payments
Although the payments will be larger with a shorter term mortgage, you’ll save a considerable amount of money in the long run in terms of interest and the total amount you’ll ultimately pay back (usually tens of thousands of pounds). Just be sure that the shorter period works with your budget.
If your objective is to pay as little interest as possible, you’ll want to pay the mortgage back over as short a period of time as you can. By shortening the mortgage term you’ll reduce the interest you pay back but your monthly payments will be higher. Just remember to ensure that you can afford the monthly payments comfortably over the shorter term you have chosen.
On the other hand, if you want to keep your monthly payments as low as possible, you can achieve this by choosing a longer term with your lender. But, whilst this means you’ll be paying out less per month, it does mean you’ll pay more interest over the term of your mortgage. Also note that if you choose a term that means you will be paying monthly payments on your mortgage into your retirement, you’ll need to ensure that you have a plan for how you’ll do this.
Longer term means more interest
To explore the impact length of term can have on the total interest you pay, let’s look at an example. Someone who has taken out a £150,000 mortgage at four per cent over 25 years will pay £87,526 in interest. If they decide to extend the mortgage term to 30 years, the amount of interest you pay will rise to £107,804, whilst a 35-year mortgage will lead to a total of £128,948 in interest. As you can see, you’ll always pay back a lot of interest on a mortgage because you’re generally borrowing the money over a long period of time. But, our examples show that the interest can vary significantly depending on the term you choose.
Making extra payments on a mortgage
Some mortgages enable you to make overpayments, which can give you some flexibility. With this mortgage feature, you may start with a longer term to keep your monthly payments lower, but allows you to make extra payments on top of the agreed contractual monthly payment whenever you can afford to do this. The extra payments are therefore optional, but when you make them they reduce the amount of capital outstanding on the mortgage. This in turn reduces the amount of interest and the time you have the loan is reduced from the original term. Mortgages with this overpayment feature ensure that you don’t over commit yourself on monthly payments on your contracted term, but you still have the option to pay more when you feel you can.
Whilst not all mortgage products offer complete flexibility on how much extra you can repay on top of your contractual monthly payment, most mortgage products will allow people to pay a little bit extra each year without any penalties, 10% of the outstanding mortgage balance in addition to the monthly repayments is the average. This can help cut down on the interest that needs to be paid on the mortgage over all, as well as potentially cutting the length of the mortgage itself. If you haven’t specifically chosen a mortgage that’s flexible on overpayments, before you attempt to pay anything extra above your usual monthly repayments, check with your lender to see how much extra you can pay without incurring a charge.
So, what should I do?
The most important thing when taking out any mortgage (or indeed any type of loan) is to ensure that you’ll be able to afford to make all the monthly repayments both now and in the future. Although 25 years is the most common term chosen for mortgages, it’s important to remember that you can choose whatever term you feel comfortable with. Whilst not always the case, the objective for most people is generally to pay the debt off as early as possible without putting yourself under undue financial pressure.
Ultimately, the decision is up to you, what you can afford each month and how you want to run your monthly budget now and in the future. Remember to shop around to make sure you get the best deal you can for the type of mortgage you want. And, make sure you take the time to compare mortgages with different terms before you make your final decision or ensure you get the best advice from your mortgage broker.