The 30-year fixed-rate mortgage has been one of the most popular ways that homeowners in America have financed new home purchases. What is this mortgage mainstay’s secret of success? Is it the right option for you when you buy? What if you want to refinance?
Read on to find out more.
How Does a 30-Year Fixed-Rate Mortgage Work?
Your lender agrees to lend you the money you need to buy your home, and you agree to pay that money back over 30 years.
You make fixed (think: predictable) mortgage payments each month.
When the principal meets the interest and it gets capitalized, that’s amortization 🎵
Interest is amortized over the life of the loan. (Your amortization schedule breaks down how much each payment you make goes to paying off interest and how much goes to paying off your principal balance.)
You pay more in interest upfront. And over time, more and more of your monthly mortgage payment goes toward paying down your principal balance. The longer the loan, the more interest you pay.
Interest rates have been tracked consistently since 1971 and are usually based on benchmarks set by the U.S. Federal Reserve.
Except for record highs between 1979 and 1985 and current record lows between 2010 and our present day, the average interest rate for a 30-year mortgage has stayed in the 5% – 10% range for most of that history.
Pros of a 30-Year Fixed-Rate Mortgage
Let’s explore why 30-year fixed-rate mortgages have been a favorite of homeowners for 5 decades and counting.
Affordability: Paying off the loan over a longer period means you can borrow more and afford a more expensive home while staying within your budget.
Fixed payments: Paying the same amount every month for the life of the mortgage means it’s easier to budget and plan ahead.
Long-term investments: Because home values historically rise over time, the value of your home is likely to go up as you pay down your mortgage balance. That gives you 30 years to build up equity in your home.
Cons of a 30-Year Fixed-Rate Mortgage
Pay more interest: Because you’re paying for your loan over a longer period, you pay more in interest, especially at the start of the mortgage.
Longer repayment period: With a 30-year mortgage, you have to wait longer to own your home outright. Because your payments go toward interest first, it may be some time before you see the amount you owe significantly drop.
Can You Refinance a 30-Year Mortgage? Considerations
Refinancing a 30-year mortgage usually isn’t a problem. If you have good credit and your home is in good condition, most lenders will refinance your mortgage payments. Just make sure you’re refinancing for the right reasons.
Refinancing for a lower rate
Depending on the interest rate you got when you first took out your mortgage, refinancing to get a lower interest rate can work to your advantage. Lowering your interest rate by a percentage point or more can save you hundreds of dollars every month and potentially tens of thousands of dollars over the life of your mortgage.
Refinancing to prepay
You can also refinance to prepay your mortgage. You refinance to lower your monthly payment, then you keep paying the same amount that you’re currently paying. That extra money goes toward the principal balance, which makes it possible for you to pay down your mortgage faster.
Refinancing to a shorter term
When you refinance from a 30-year fixed-rate mortgage to a new 30-year fixed-rate mortgage, even if your payments are lower, your payment schedule (aka your amortization schedule) resets, and the bulk of your early monthly mortgage payments will be applied to the interest.
It may make sense to refinance to shorten the length of your mortgage to a 20- or 15-year loan.
Because the loan is shorter term, you may have to pay a little more each month, but you’re likely to qualify for a lower interest rate with a shorter-term mortgage, so you’ll pay less in interest and you’ll own your home sooner.
How To Qualify for a 30-Year Fixed-Rate Refinance
To qualify for a 30-year fixed-rate mortgage refinance, check the eligibility criteria for:
Credit score: For a conventional loan, you’ll need a credit score of 620 or higher. The higher your credit score, the better interest rates you’ll qualify for.
If you don’t meet that requirement, don’t sweat it. There are government-backed options you may qualify for, like a Federal Housing Administration (FHA) loan, a Department of Veterans Affairs (VA) loan or a U.S. Department of Agriculture (USDA) loan.
Debt-to-income (DTI) ratio: Ideally, your monthly debts – including your current mortgage payment, credit card debts, student loan payments, auto loan payments and any other fixed monthly debts – should be less than 41% of your gross monthly income. If it’s higher, it will be harder to qualify for a good interest rate when you refinance.
Income history: Lenders want to know that you’ll be able to continue to make your mortgage payments. Showing consistent proof of income with pay stubs, tax statements or profit and loss statements if you’re self-employed can help you qualify for the best interest rates.
You’ve Got the 30-Year Mortgage Know-How
The 30-year fixed-rate mortgage has been the gold standard for a long time – and for good reason. It offers stability and makes it possible to afford a more expensive home because your mortgage payments span 3 decades.
But take note, a 30-year mortgage puts you and your lender in a relationship that isn’t going to end suddenly. Take the time to make sure you’re working with the right lender and that you’re saying “I do” for the right reasons if you want to buy a home or refinance.
FRED, Federal Reserve of St. Louis. “30-Year Fixed Rate Mortgage Average in the United States.” Retrieved September 2021 from https://fred.stlouisfed.org/series/MORTGAGE30US#0