Should Home Buyers Choose a Short- or Long-Term Mortgage?

The Preferred Option Depends Upon a Variety of Factors

Chung Baek, PhD, and Khamis Bilbeisi, PhD

Choosing the term of a home mortgage is one of the most difficult decisions borrowers have to make, especially for those who can afford either a short-term mortgage payment or a long-term mortgage payment. Because there are many factors that influence the choice of mortgage term, given additional investment opportunities, making a clear-cut decision is difficult. Using a Monte Carlo simulation, the authors conclude that an individual's marginal tax rate is the key factor for borrowers who plan short-term homeownership, whereas the mortgage interest rate is the key factor for borrowers who plan long-term homeownership. Mortgage term decisions can be quite different due to the different effects of major factors. If, however, the home mortgage market correctly reflects information about those factors, it is expected that mortgage borrowers will have an individual preference for either a short- or long-term loan.