Posted on 06/02/2003 4:23:28 PM PDT by Dog Gone
With mortgage rates setting new lows last week, a growing number of homeowners are doing something that was largely unheard of just a year ago: taking out 10-year mortgages.
It's part of a broader push by many borrowers to pay off their mortgages quickly by taking advantage of the lowest interest rates in more than 40 years. Some are baby boomers who want to get rid of their debt before they retire. Others are simply trying to save on interest costs by shortening their mortgages.
The interest savings on a 10-year mortgage are enormous. If someone borrowed $250,000 at 4.5 percent, the going rate at a major lender, the interest over the life of the loan would be only $60,915. By contrast, in the case of a homeowner borrowing that same amount for 30 years at 5.375 percent (longer-term loans typically carry higher rates), the interest would total $253,974.
The drawback, of course, is that your payments are higher in the short term. On that same hypothetical $250,000, the monthly payments would be $2,591 with a 10-year loan, compared with $1,400 for the 30-year loan.
At Countrywide Home Loans, a unit of Countrywide Financial Corp., 10-year mortgages now account for roughly 15 percent of mortgage loans. The volume of 10-year loans "was insignificant a year ago," says Doug Perry, first vice president of Countrywide Home Loans.
To spur demand, Countrywide has been sending direct-mail solicitations explaining the benefits of shorter loans to borrowers who are prepaying their existing longer-term mortgages.
Borrowers have been gravitating to 15-year mortgages from 30-year loans for some time. But the new 10-year loans are providing a fresh inducement even for people who have refinanced relatively recently.
Rich Schroeder, an account manager for a transportation company, took out a 15-year mortgage with a 6.5 percent rate last year. Now, he is switching into a 10-year, $116,000 mortgage with a 4.875 percent rate.
"I'm looking to get out from underneath the mortgage as quickly as possible," says Schroeder, who lives outside Detroit. The new loan will allow Schroeder to pay off his loan nearly four years earlier, while adding only $100 to his monthly payment. Schroeder says he considered refinancing four or five months ago, "but it wasn't worth making a move."
Earlier this year, the mortgage industry braced itself for a sharp decline in refinancing activity as the economy seemed poised to recover, which would drive rates up. Instead, the economy has remained soft, and fears of deflation have pushed rates to their lowest levels in decades.
The result is that refinancing activity is surging. The Mortgage Bankers Association recently boosted its estimate of 2003 mortgage volume to $3 trillion, up from last year's record $2.5 trillion.
Interest in the shorter loans is helping spur the latest round of refinancing. In April, U.S. Bank Home Mortgage introduced a 10-year fixed-rate mortgage that carries a lower rate than its 15-year mortgage; previously, the two mortgages carried the same rate.
"Our phone literally has been ringing off the hook," says Dan Arrigoni, president of U.S. Bank Home Mortgage, a unit of U.S. Bancorp.
Shorter-term mortgages of all types are gaining ground. At GMAC Home Finance, a unit of General Motors Corp., 15-year mortgages accounted for nearly half of recent refinance loans. Last year, about 20 percent of GMAC customers who refinanced opted for a 15-year mortgage. Chase Home Finance, a unit of J.P. Morgan Chase, says 15-year mortgages now account for about 20 percent of the loans in its pipeline, up from 15 percent six months ago. More borrowers also are refinancing their 30-year mortgages into 20-year and 25-year loans, lenders say.
On Tuesday, rates on 30-year fixed-rate mortgages averaged 5.51 percent, while 15-year fixed-rate loans averaged 4.95 percent, according to HSH Associates, financial publishers in Butler, N.J.
Mortgage rates could drop even further if the economy shows further signs of weakness. Mortgage rates typically track rates on Treasury bonds.
Of course, many homeowners aren't interested in shorter mortgages. Instead, they are using the low rates to lower their monthly payments. Or, they are taking cash out when they get a new mortgage.
Indeed, short-term mortgages aren't for everybody. Borrowers are committing to a higher payment for the life of the loan. If a homeowner's income drops, she will still have to make that steeper payment.
You can achieve some of the same benefits of shorter-term mortgage simply by taking out a 30-year mortgage and making extra principal payments. Pinched for cash? Make the minimum payment. One hitch: You typically won't get as low a rate on a 30-year mortgage as on a shorter-term loan. And many find it hard to stick with this self-imposed mortgage prepayment strategy.
In addition, people taking out a 10-year mortgage will quickly whittle away one of their biggest tax breaks: the deduction for mortgage interest. Principal payments aren't tax deductible. In the first year, the interest deduction for a 10-year mortgage at 4.5 percent is only about a fifth smaller than a 30-year mortgage at 5.375 percent. But by the fifth year, a borrower in the 27 percent bracket would see the deduction cut almost in half, calculates PricewaterhouseCoopers.
Borrowers don't always get a break for taking a shorter-term mortgage. Twenty-five-year loans are typically priced at the same rate as 30-year mortgages. Likewise, Bank of America Corp. offers the same rate on 10-year and 15-year loans. As a result, the bank says its customers are more likely to take out a 15-year mortgage and pay it off early if they are inclined.
Still, for many borrowers, a shorter-term loan has clear benefits. It allows homeowners who are several years into their current mortgage to take advantage of low rates without stretching out payments for another 15 or 30 years.
Don Genereux, an elementary school principal in Minneapolis, is replacing his $88,000 fixed-rate mortgage, a $25,000 home equity loan and some high-cost debt with a new $115,000, 10-year fixed-rate mortgage with a 4.375 percent rate. The new loan will boost Genereux's monthly mortgage payment by about $15 but cut his total borrowing costs by about $500 a month. Genereux, 55 years old, says he was already five years into his 15-year mortgage and didn't want to extend his loan further. "We're looking at retirement and change of career," he says. "We need to have a light at the end of the tunnel."
Just remember that you can get a mortgage while you're working, but once you retire, all of the money you have in equity is tied up there. You can't likely get it for anything else.
But the bottom line is, by paying off a mortgage in a shorter period of time than it is amortized, you can save yourself tens of thousands of dollars.
And after the house is paid off, wouldn't it be more fun to invest one THOUSAND dollars a month instead of one HUNDRED?
Or maybe it does. Sometimes economic analysis makes my eyes glaze over.
Another problem for me in most economic analysis is that when you discount large sums of money 10 years or more into the future into present worth, you end up with peanuts anyway, especially if you use discount rates of 9% or more.
Hmmmm, much to think about.
Use a Little of both methods, Spread the odds so to speak.
Absolutely, but I would not do it if it meant channeling all or most available funds into a non-liquid asset. If most of your money is tied up in a house, I think you lose a lot of flexibility.
I agree with that, but I certainly don't want to be paying a mortgage after I'm retired, do I? I would think the goal would be to have no mortgage when income drops at retirement.
Either that, or liquidate entirely and be a renter. The problem with that is retirement income may be tied to a fixed pension in many cases and not rise as fast as rents would.
There's two advantages to this. First, you gain some satisfaction in knowing that you will be keeping a lot of the interest that would otherwise have gone to the bank. And, should a financial hardship occur unexpectedly (and isn't that when they ALWAYS occur???), you would be able to weather the hardship a lot easier if you can fall back on the lower 30 year payment instead of worrying about HAVING to make the higher 10 year payment.
Further, if I'm understanding you correctly, you can "borrow" each month an amount equal to your "extra" monthly payment, with an interest rate equal to your mortgage rate multiplied by one minus your tax bracket, with no closing costs or credit approval requirements.
If you think the prospects for your current job look iffy, you can drop your monthly payments to the base amount while you still have your job, and put that money into a reserve fund. In other words, you pay a little bit extra for the longer-term (on paper) mortgage, but in exchange for that cost you get much more flexibility.
Wow. Give me a couple of days to digest that.
If you think the prospects for your current job look iffy, you can drop your monthly payments to the base amount while you still have your job, and put that money into a reserve fund. In other words, you pay a little bit extra for the longer-term (on paper) mortgage, but in exchange for that cost you get much more flexibility
Yes. And for however long you made the extra payments, you denied your bank that much more interest. And then when you get back on your feet, you go "Ha, ha!" to your bank and start cheating them out of all that interest money again.
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