The Case for 10-Year Loans
Question: We expect to retire in about a decade and want our home paid off by then. Lenders make loans for 30 years and 15 years. Do they make them for 10 years as well?
Answer: While it’s not especially common, lenders certainly can originate 10-year mortgages and will be happy to do so. The reason lenders are delighted to offer 10-year financing is that such mortgages represent little risk because the loan balance is rapidly reduced and there’s no chance the borrower can hang on to the loan for 30 years—good news for lender that do not want their funds tied up at one fixed rate for a long time when better rates are available.
There are a number of attractions with 10-year mortgages.
First, interest rates fall as loan terms get shorter because with shorter loans there is less rate risk for lenders.
Second, monthly payments rise as terms get shorter because there is less time to repay the debt.
Third, there is a substantial rate discount between 30-year financing and rates for 10-year loans.
Let’s look at a comparison. Imagine that you can get a $200,000, 30-year, fixed-rate financing at 4%; 20-year loans at 3.75%; 15-year loans at 3.35%; and 10-year loans at 3.25%. The monthly payments for principal and interest look like this:
- 30 years: $954.83
- 20 years: $1,185.78
- 15 years: $1,415.08
- 10 years: $1,954.38
If you choose the 10-year mortgage, the minimum monthly payment will be $1,954.38. Under the terms of any mortgage financing you would not be allowed to pay anything less. This might be a problem if in the future you have income loss because of reduced hours, a job ends, or a business closes.
To have both a lower required payment and a shorter term you might do better with a 15-year loan and then prepay $539.30 each month ($1,954.38 less $1,415.08 = $539.30). If something goes wrong you are only obligated to pay the smaller $1,415.08 monthly payment. Notice that rates for 10-year and 15-year mortgages are close in this example so there’s little disadvantage if you elect the shorter loan term.
If you do elect to go with a 15-year mortgage, e sure to check the lender’s Loan Estimate (LE) sheet to assure there’s no possibility of a penalty if you prepay the loan in whole or in part. Look at the middle of the form’s first page to see if the financing has any prepayment penalty. As always, shop around before selecting a lender.
– Peter G. Miller, CTW Features