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."
Correct. That's why you ask for the reports. And then you make a decision with all the facts at your disposal.
Yes, you do. You want to be paying a mortgage at the highest payment you can afford on your pension and SS. It's like a fixed rent.
After you're retired, you need to have as much money as possible in liquid investments. You probably will never be able to get another good mortgage again (I think the reverse mortgages are expensive and only useful if you are desperate)
Here's the big tax advantage...
You Pay 2 dollars. The Government gives you 1 dollar.
If you like this deal, I'm paying back 40% of all the dollars you give me! Open to all Freepers!
ampu
That doesn't sound very smart. The stock market has gone up over 20% in the last 7 months. And it looks like it will go up even more. Do you really think the value of your house will go up >20% in the next 7 months?
Whats your porfolio?!!
The way jobs are going now though ---it seems it could be pretty risky for someone to go to the maximum of their monthly income, in a year or two they might lose their job, even if they manage to find another good job within 6 months, it could cost them their home if they get behind on payments. I've thought about paying extra on my mortgage, but I decided instead to try to get 5-6 months mortgage payments saved up just in case.
I'm going to have to think about that. While I agree that equity in a home is illiquid while you're living in it, the money that you have to devote from your retirment income to pay a mortgage is at least as illiquid. Plus the money you earn on your assets that would otherwise be in a fully-paid for home has to generate a return after taxes that exceeds your interest payments (also after tax considerations are considered).
You'd definitely come out a winner if interest rates rose significantly after getting a new mortgage, because a conservative retired investor could invest in T-bills or CDs that generate a good yield, but I don't think it's that clear in flat interest rate scenario.
I just refinanced, and they had the best rates I could find. A great deal depends on what term loan you want. The shorter term loans (3 or 5 year ARMs and 5 or 7 year balloons) have the best rates right now. Depending on your time horizon, the difference in the rate may be worth a shorter term loan.
Don't forget that the reduced home mortgage interest also has an effect at tax time. The feds let you write off that interest, so they pay a part of the monthly mortgage payment. At a lower interest rate, you will have to set more aside for federal taxes...or shelter what you can in an IRA or 401K.
To take the logic just a little further: how long will interest rates and other rates of return (stock market returns, certificates of deposit, etc.) remain as low as they are today. Six months? One year? Two years? If you think you can make 5% or more annually through some other investment, you should consider maximizing your mortgage and investing the cash. Risk of loss is something else to consider: a Baby Boomer with retirement in a few years will want to steer away from riskier investments, but the point is still the same. The totally risk-averse person should just go ahead and pay down the mortgage - which is a nearly risk-free return equal to the mortgage rate.
Locking into a generally long-term mortgage at today's ridiculouslly low rates is a very good thing for several reasons. First of all is the obvious lower interest rates. Second, this will generally provide the lowest minimum payment. A lower minimum payment maximizes your personal liquidity and ability to deal with unexpected problems without the threat of defaulting or messing up your credit scores. Third, you can almost always make additional principal payments.
Another wrinkle to consider is that the tax-deductability of a mortgage is front-end-loaded. If you arrange for your payments to be equal over the term of the loan, your earlier payments will cost you less than your later ones.
Certainly true if you currently own a home which you are going to stay in for a long time. I personally don't think it's the best time to be buying a home, though, since the low interest rates have pushed up home prices considerably. IMHO, it's probably in many ways better to have a smaller loan at a higher interest rate than a larger loan at a lower rate, especially if the higher loan has a very high LTV. If someone buys a home now and interest rates go up (forcing home prices down), they may be able to afford the fixed monthly payments but may be quite unable to afford to sell the house (since the falling market would kill their equity, and any replacement house would have to be bought at a higher interest rate).
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