You probably know the FHA loan program provided stability in the financial markets during the hardships of the Great Depression. By introducing loan guidelines that, if followed by banks, would carry a guarantee to the lender, banks felt more comfortable approving the loan. One of the main guidelines was the term of the loan, or how long the loan would last if the borrower made the proper payment each month until the loan was paid off. Each month, a portion would go to interest to the bank while another portion would be allotted directly to the outstanding balance of the loan. Initially, there was only a 15 year FHA loan term. However, today there are other choices.
Most FHA loans today are spread out or amortized at 30 year period. This loan term stretches out the repayment period providing the lowest monthly payment, increasing the borrowers’ buying power. If there is a drawback, it’s the amount of long-term interest paid to the lender. A shorter term pays much less interest to the lender but has much higher monthly payments due to the tightened term.
For example, if you take a 4.0% rate over 30 years with a $200,000 loan amount, the principal and interest payment is $954 per month. If you compare that same rate and loan amount amortized over 10 years, the principal and interest payment is $2,024, more than twice the amount when the loan is amortized over 30. The total amount of interest paid with the 30-year term is nearly $145,000 compared to the interest paid with a 10-year term of $43,000.
With a 30 year loan, the first payment is comprised of $288 to the loan balance and $667 to interest. The first month’s payment with a 10 year loan is $1,358 to the loan balance and $667 in interest. You can easily see that choosing a shorter FHA loan term saves you money in long term interest but at the same time while that’s an ideal feature the payments are also so much higher.
Today, while most FHA loans are amortized over 30 years, the second most popular term choice is a 15-year term. Again, with a 4.0% rate on a $200,000 loan amount, the 15-year term provides a $1,479 monthly payment. While borrowers may see the shorter terms saves them money over the longer term the monthly payments may be just too much.
Yet there are other loan terms offered by lenders that might better suit the desire of paying less interest as possible while still keeping monthly payments affordable. For example, borrowers can select a loan term of say 20 years or even 25. Some borrowers can also choose to take the longer term 30 year fixed rate loan yet make additional payments each month, once per year or at anytime extra funds are available. Borrowers can then choose the 30 year but make extra payments each month as if the loan term was 15 years. The FHA home loan does not have any prepayment penalties which makes this an option for those who like the lower monthly payments of the 30-year loan but want to save as much as possible in long-term interest. Learn more about the FHA loan process here.
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