When it comes to financing a property, borrowers tend to focus on the size of their mortgage rather than the duration of the loan. However, this can be a mistake, with the length of your home loan equally influential in achieving your financial goals.
While a 30-year loan is the most common option for homebuyers, the average mortgage duration is actually shorter than that. This is because borrowers have the option to make additional mortgage repayments and accelerate their path to financial freedom.
For those who are looking to pay off their mortgage faster and reduce their interest costs, a 20-year loan is another option to consider.
In this article, we will explore the advantages and disadvantages of both short and long home loan terms, helping you determine which option is best for your financial circumstances.
What are the advantages and disadvantages of a 20-year home loan?
- Less total interest paid: Opting for a shorter mortgage term such as a 20-year loan can significantly reduce the interest costs paid to the lender over the life of the loan, potentially resulting in savings of tens or hundreds of thousands of dollars. This is because under the lending structure, the longer you hold a mortgage, the more interest you will have to pay.
- Lower interest rate: Typically, lenders will offer a lower rate to borrowers opting for 20-year home loans than for those on longer terms. This is because the bank views shorter home loan terms as less of a risk, as well as the potential to make larger profits in the long term.
- Faster equity buildup: As a 20-year mortgage requires making higher monthly repayments, it enables you to build up equity faster in your home. This means that if you are forced to sell or refinance in the future, you will be in a stronger financial position with a greater share of the asset.
- High monthly repayments: A 20-year home loan term requires larger repayment sizes in order to pay off the loan faster. This can add a lot of pressure to your monthly budget and put you under significant strain during times of financial hardship.
- Limited borrowing capacity: Since the monthly repayments are higher, you may have to settle for a smaller loan size than your income could allow, which can limit your price range when buying a property.
- Restricted cash flow: With higher repayments needed to pay off your loan faster, a greater portion of your income will be allocated towards your mortgage, leaving you with less cash on hand. This can make it challenging to invest in other areas and will limit your financial flexibility.
What are the advantages and disadvantages of a 30-year home loan?
- Lower monthly repayments: A longer home loan term will mean lower monthly repayments, making it easier to build up your savings and giving you more freedom in your weekly budget.
- Increased flexibility: With a 30-year mortgage and lower repayments, you’ll have more flexibility and options with your money. Depending on your current financial circumstances, you can make additional loan repayments, grow an offset account or enjoy discretionary expenses such as holidays.
- Greater borrowing capacity: Having more room in your monthly budget means you’re able to qualify for a higher loan amount. Lenders will likely feel more confident in your ability to repay the loan when they see that you have a greater capacity to meet your loan repayments.
- More access to cash: With less of your earnings needed for your repayments, you’ll have more cash available to save, spend or invest. This can be particularly important over the course of a 30-year loan term, as your financial goals and needs are likely to change and evolve over time. With extra cash on hand, you'll be better equipped to meet unexpected expenses or take advantage of new opportunities that arise.
- Higher interest costs: The longer it takes to pay off your mortgage, the more interest you'll end up paying. Opting for a 30-year home loan term can result in paying tens or even hundreds of thousands more in interest costs compared to a shorter loan term.
- Slower equity buildup: Because a larger portion of your monthly mortgage payment goes towards interest instead of principal, your equity in your home will grow slower compared to a shorter-term mortgage. This can become problematic if you need to sell or refinance your property early, or if you're looking to use your home equity to purchase an investment property.
- Higher interest rates: Due to the many potential personal and financial changes that can happen over a 30-year loan term, lenders often view these loans as riskier. As a result, they may charge higher interest rates compared to shorter-term loans. Unfortunately, these higher rates can add up over time, resulting in thousands of dollars in additional mortgage costs.
Three things to consider when choosing the length of your mortgage
Your retirement age
When entering into a mortgage, the age you plan to retire should be one of your primary considerations.
For almost every borrower, we recommend aiming to be completely debt-free well before the time you retire. This will give you time to consider possible income streams for retirement without needing to make monthly mortgage repayments. The last thing you want hanging over you in retirement is a mortgage, so make sure that the length of your home loan does not exceed this deadline.
For example, if you are 45 years old and buying your first owner-occupied home, a 30-year mortgage would mean paying back the loan well into your 70’s. To avoid putting yourself under a lot of financial stress later in life, develop a financial plan that ensures you pay off the mortgage before you reach retirement age.
Offset accounts can be a great way to limit your interest costs while maintaining a healthy cash flow, and are another important consideration when choosing the length of your mortgage.
Essentially, an offset account is a type of savings or transaction account that is linked to your mortgage. The balance in the offset account is offset against the outstanding balance of the mortgage, reducing the interest charged on the loan.
An offset account can be a wonderful tool in your kit, especially for borrowers with longer-term loans. It allows them to save and spend at their discretion while mitigating the large interest costs associated with a 30-year home loan. In short, an offset account can save you money and give you added flexibility with your mortgage.
Your future plans and needs
When considering the length of your home loan term, it's important to keep in mind that your financial situation will likely look very different in 20 or 30 years from now. When talking about such a large period of your life, there are many different factors and variables that could impact your ability to meet your monthly repayments throughout your mortgage.
For instance, starting a family can entail significant expenses that will substantially alter your weekly budget. Therefore, if you intend to have children during your mortgage tenure, it's crucial to provide yourself with some financial leeway to adapt to this change. Opting for a shorter-term home loan with higher monthly repayments may lead to considerable financial pressure once the bills start piling up.
What is our final verdict?
As always, the best option will depend on your individual and financial circumstances. However, we can offer you the same guidance we offer to many of our clients.
Generally, opting for a 30-year mortgage and taking advantage of features like an offset account gives you the flexibility to enjoy the best of both worlds. This will allow you to grow cash savings and build equity in your home at your own pace, whilst also offsetting the additional mortgage costs in a savings account.
Even for those who wish to pay down their home loan quickly, a 30-year mortgage can still be a wise choice. During times of financial stability, borrowers have the option to make additional principal repayments to accelerate the loan payoff. However, if any unforeseen circumstances arise, such as a change in employment, poor economic conditions, or illness, your budget may begin to feel strained. In such cases, having access to cash or liquid assets can provide an invaluable safety net, giving borrowers the confidence that they can tackle life's challenges without sacrificing their financial goals.
We believe that flexibility is key for borrowers because of how much can change over the lifetime of a loan. It allows them to adapt to unexpected events and challenges that will inevitably arise.
Of course, there are also circumstances in which a borrower may be better suited to a 20-year home loan term.
Borrowers with confidence in their long-term earning capabilities and enough room in their budget may prefer the lower rates and reduced interest costs that come with a 15 or 20-year loan term.
Other borrowers simply don’t trust themselves with additional access to money and would rather see excess income go straight towards the principal of the house. Additionally, older homebuyers may also find shorter home loan terms more suitable in order to pay down their debt well before retirement.
Before you make a decision, it’s always best to speak to a trusted professional who can work through your current and future financial goals. To discuss the best strategy for your home loan journey, you can book in a free chat with our finance team at any time.
You can also use our mortgage repayments calculator to estimate what your repayments will look like over the chosen length of your mortgage.