If you’re planning to buy a home, you’re either in it for the long or short haul — and in either case it’s important to understand the mortgage options available to you. Getting a 30-year home loan is the norm for most buyers. But given that the typical homebuyer expects to stay in their home for a median of 15 years, you may have some good reasons to consider a shorter mortgage term instead.
What is a short-term mortgage?
Broadly speaking, short-term mortgage loans are ones that don’t fit the typical 30-year term mold. Examples of short-term mortgage options include fixed rate loans with 5-, 10-, 15- and 20-year terms. Adjustable-rate mortgages (ARMs), bridge loans and reverse mortgages can also fit into this category.
With an ARM, borrowers pay one low fixed interest rate for the first few years of the loan term. The rate then adjusts for the remainder of the loan term, based on changes in an underlying benchmark or index rate. So, if you were to take out a 7/6 ARM, for example, the loan would have a fixed rate for the first seven years. Once the initial rate period ends, your loan rate would then adjust every six months going forward.
A bridging loan is another type of short-term mortgage. Bridge loans can be used to fill a temporary financing gap. So, say that you want to buy a fixer upper home and flip it for profit. If you expect to be able to sell the home within the next 12 to 18 months, you could get a short-term bridge loan with a two-year term. Just keep in mind that bridging loans might require a balloon mortgage payment (a large, lump sum payment) at the end of the term, which means you’d need to be confident you could sell the home to pay back what you owe.
A reverse mortgage or Home Equity Conversion Mortgage (HECM) could also be considered a short-term mortgage. Even though it has mortgage in the name, it’s not the same as a standard home loan. With a reverse mortgage, the homeowner receives regular payments based on the equity value of their home, rather than paying money to a lender. That money must be repaid once the homeowner passes away or sells the property. (Senior citizens often take out a reverse mortgage to provide supplemental income in retirement.)
Benefits of a short-term mortgage
Short-term mortgages can offer some distinct advantages over a traditional 30-year mortgage, starting with interest savings. Short-term mortgage loans, like the 15- and 20-year terms offered by Ally Home, can offer more favorable interest rates compared to longer mortgage loans. A lower rate, paired with a shorter loan term, means you’ll pay less interest overall to borrow.
Short-term mortgages also make it easier to own your home outright faster. Instead of making payments for 30 years, a shorter loan means you could pay your home off in 10 or 15 years instead. This can free up money that you could use to pursue other important financial goals, such as saving for retirement or planning for your child’s college expenses.
A shorter loan term could also be appealing if you’re hoping to build equity in the home at a faster pace. Home equity represents the difference between what the home is worth based on current market value and how much you owe toward your mortgage. If necessary, you could tap into that equity later through a home equity loan or home equity line of credit to finance repairs or improvements, pay for college costs or fund another expense.
Downsides to a short-term mortgage
Short-term mortgage loans are not right for every homebuyer. While you could save money on interest and pay your home off faster, you’re making a trade-off when it comes to the monthly payment. Since you’re opting to pay the loan off over a shorter term, that likely means paying more toward the balance each month.
Aside from that, it can be difficult to find a lender that’s willing to offer specific short-term mortgages, such as 5- to 10-year loans. And if you are able to find one, you may need to meet stricter credit score requirements or income guidelines to get approved.
How do you qualify for a short-term mortgage?
Qualifying for short-term mortgage loans is based on the same factors that a lender considers when applying for a 30-year mortgage. So that includes your:
- Credit scores and credit history
- Debt-to-income (DTI) ratio
You’ll need to have money for your down payment, as well as closing costs. If you’re getting a conventional mortgage loan with a shorter term and you want to avoid private mortgage insurance, you’d need a down payment of 20% or more. In general, closing costs typically run between 2% and 5% of the home’s purchase price.
As with other mortgage loans, your lender will need to be confident you can repay what you borrow. Running the numbers through a mortgage payment calculator can help you estimate what your monthly payments might be and whether getting a short-term mortgage is realistic for your budget.
Can I refinance into a short-term mortgage?
Refinancing a mortgage could help you to secure a lower interest rate, which could save you money. You could also pay off your mortgage faster if you’re moving from a longer-term mortgage to a short-term home loan.
Whether it makes sense to refinance to a shorter loan can depend on how much you’ve paid down on your original mortgage and how much you’d have left to pay. If you’ve already paid down most of the interest on your current loan, you may not save much on interest costs by switching to a short-term mortgage. On the other hand, you could still get the benefit of paying the home off in less time.
The bottom line: Is a short-term mortgage right for you?
Short-term mortgages can serve different purposes, depending on the type of loan. You might choose one if you’re buying a starter home and intend to move within a few years, you want to lock in a low rate or you want to be free and clear of a mortgage sooner rather than later. In those instances, a short-term mortgage may just be the commitment you’re looking for.
Learn more about your mortgage options with Ally Home.