When you’re shopping for a mortgage, you’ll quickly discover that the 30-year fixed-rate mortgage is the go-to for most home buyers. But maybe you’re not interested in a long-term commitment with a mortgage.
A short-term mortgage is a home loan with a shorter repayment period than a traditional 30-year mortgage. These loans are typically used by borrowers with a financial goal in mind, such as building equity faster, getting a lower interest rate or maximizing future profit when they sell.
This article will explain what short-term mortgages are, how they work and their pros and cons so you can make the right decision on your home buying journey.
Short-Term Mortgage: The Basics
There are many loan types under the short-term mortgage umbrella. While each loan type is unique, they all have one key element in common: a shorter repayment period.
We put together a list of common short-term mortgage options you may encounter:
- Fixed-rate mortgages: A home loan with an interest rate that stays the same for the entire term of the loan. Short-term fixed-rate mortgages usually come with 10-year or 15-year terms.
- Adjustable-rate mortgages (ARMs): ARMs offer a lower interest rate for a 3- to 10-year introductory period that later adjusts (becomes variable), usually changing with an index. Home buyers who take out ARMs usually plan on selling or refinancing the home before the introductory period ends.
- Interest-only loans: Interest-only mortgages charge borrowers interest for a set time, typically 3, 5, 7 or 10 years. At the end of the interest-only period, the monthly mortgage payment starts to cover interest and the principal loan balance.
- Balloon loans: Borrowers who take out balloon loans make low monthly mortgage payments over the life of the loan. At the end of the loan’s term, the borrower makes a large, one-time payment on the outstanding loan balance. Balloon loans are best for borrowers who are interested in low living costs or don’t plan on living in a home very long.
- Bridge loans: Bridge loans typically last a year or less. Bridge loans give borrowers money to finance the purchase of a new home before the sale of their existing home.
Most borrowers who opt for a short-term mortgage typically want to:
Build equity faster at a lower interest rate
To build equity fast at a lower interest rate, borrowers will likely consider 10-year or 15-year fixed-rate mortgages or adjustable-rate mortgages (ARMs). The loans are usually offered by traditional lenders that conform to Fannie Mae and Freddie Mac’s conventional loan requirements.
Minimize the cost of ownership to maximize profit
Mortgages, like interest-only loans or bridge loans, are designed to minimize the overall cost of ownership and maximize profitability when it’s time to sell. The loans are typically issued by nontraditional lenders, and their terms – such as interest rates, amortization schedules and more – will vary.
Nontraditional mortgages don’t fit the requirements of conventional loans. They often have lower credit score and debt-to-income (DTI) ratio requirements.
How Short-Term Mortgages Work
Applying for a short-term mortgage is a lot like applying for any home loan. You’ll go through the underwriting process with a lender and provide documentation about your finances, employment and credit history.
You close on a short-term mortgage the same way you would with any other home loan. Your lender will release payment to the seller or their lien holders, and you’ll begin making payments on your short-term mortgage.
A few key elements of short-term mortgages are worth reviewing.
Because short-term loans encompass several loan types, your monthly payments can look very different depending on the loan. Generally speaking, the shorter your loan repayment period is, the higher your monthly payment will be. But, depending on the loan type, there are some exceptions to the rule.
Short-term mortgage interest rates can be lower than 30-year loan interest rates because the lender is being repaid faster, but that’s not always the case.
Generally, the longer your loan term is, the lower your monthly mortgage payment will be and the higher your interest rate will be. Short-term, fixed-rate mortgages and ARMs usually have lower rates than their 30-year counterparts.
Also, an ARM’s interest rate will be lower upfront, but the interest rate is subject to change once the introductory period expires. While ARMs typically have lower rates, interest-only loans and balloon mortgages usually have higher interest rates because they are riskier loans.
Refinancing doesn’t have to extend the length of your loan. You can refinance to take advantage of lower rates, shorten your repayment period and more.
Qualifying for a Short-Term Loan
Depending on the type of short-term loan you want, you’ll likely need to meet different qualification requirements. Traditional lenders will often follow the underwriting guidelines set by Fannie Mae and Freddie Mac. They may specify a minimum credit score, income requirements or maximum debt-to-income ratio (DTI) for borrowers.
While some nontraditional loans won’t follow these guidelines, nontraditional lenders will require an application and will check your credit score and DTI ratio. Their requirements may be more lenient than the requirements for traditional loans, including lower credit scores and smaller down payments.
Prepare for a short-term mortgage by knowing your credit score and what’s on your credit report. You should also know your DTI ratio so you know how much house you can afford.
✅Lower interest rates
Because the repayment period is shorter, the interest rate is often lower than a traditional 30-year mortgage.
Short-term mortgages often offer more flexibility than traditional loans. For example, you may work out a unique payment schedule that meets your needs.
With fixed-rate loans and ARMs, the higher monthly payments and lower interest rates mean you’re likely to build equity and own your home faster than you would with long-term mortgages.
⛔Higher monthly payments
The shorter the repayment period, the higher the monthly payment is likely to be. This may make it difficult to afford the loan and may strain your budget.
A higher monthly payment can translate to a higher risk of default.
⛔Not widely available
Not all lenders offer short-term mortgages. You may need to shop around to find one that does.
Is a Short-Term Mortgage for You?
A short-term mortgage can be a good option if you can swing the higher monthly mortgage payments. Short-term mortgages allow you to build equity faster so you can own your home sooner. They’re not for everybody, though. It’s important to consider the disadvantages before deciding on a short-term mortgage.