Homeowners taking out 10-year mortgages

Wall Street Journal ^ | June 2, 2003 | RUTH SIMON

[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."

[Mears]

Yikes!!! The savings are unbelievable.

[Steven W.]

but the doom & gloomers worst case scenarios are dependent upon folks cashing out all their equity, throwing the cash in the street & then extending their debt back 30 years into the future. if people are, in fact, decreasing the terms of their mortgages (as many are) and paying them off quicker than expected, with more money going towards the principal and less towards interest, with the difference being used by the homeowners to increase their quality of life on a monthly basis, with that money going back into the economy, those are all tremendously good things that will have the doom & gloomers once again short covering & crying amidst their increasingly tremendous losses.

[Dog Gone]

I'm seriously considering doing this. I have a 30 year note at 6.25 with 20 years to go.

I haven't run it through a mortgage calculator, but my guess is that it's a no-brainer.

[FreeperinRATcage]

I went to a 15 year at 6.25 right before 9/11. After that, rates plummeted, but not enough to be worth incurring all the charges to refi again.

Of course, if you do have a decent amount of equity, you'd make out like a bandit.

[oldironsides]

Go to the mortgage site and work up the numbers. You will be convinced

[Thud]

All my refinances in the past 15 years have been with 15-year mortgages which I've thrown an extra $50-$100 at per month. But my children are in college now so I've been drawing down equity for the past two years - my home is pretty much my bank.

My wife wants to have a party when our first child graduates from college.

[mlmr]

I am taking out a 15 year at 4.75 through the internet. I wish I could go to ten, it would save me 17000 but I cannot manage the extra 300 per month.

[Ken H]

Check this out- http://www.1728.com/mortpmts.htm

[justlurking]

It's worth pointing out that one does not have to refinance to take advantage of a shorter mortgage. All you have to do is make an additional principle payment each month. using the =PMT() and =PV() functions in Excel, it isn't difficult to figure out how much extra you need to pay.

Of course, one reason the shortened mortgages are so popular is because you can refinance at a much lower rate and keep your payment about the same. I refinanced from a 30-year loan to a 15-year loan last year, but my payment only went up about $80/month.

I refinanced at 5%. I can now get 4.625% at the same mortgage company. I can't believe they are still going down.

[RightWhale]

This is a seismic shift. People may have borrowed all they care to and are coming back to earth. Also, if deflation is coming, people would want to get out of debt sooner rather than later. Make any sense?

[NV_Chuck]

Actually, you can still pay down principal on an existing mortgage but the interest rate is higher so you might as well get a ten year term if you can swing the payment.

On the other hand, you could alternately go for the lower payment of the 30 year loan and take the extra money and invest it something else such as the stock market or another income property. Depending on the performance of the investment, you may have more assets at the end of ten years than you would have with the shorter term mortgage. Of course if the alternate investments go sour or perform at a rate less than the tax discounted mortgage rate, you could have less assets this way.

If it's a choice of putting every extra dime to afford the ten year mortgage, you might be better off going with the longer mortgage and building up some liquid savings such as stock market and other investments. This assumes you have the financial discipline to save outside of the investment in your home.

For example, for me personally, given a choice of owning a $500,000 home outright vs. owning a $500,000 home with a $250,000 mortgage but having an additional $250,000 of cash in personal liquid savings, I would take the second situation. In the second situation, you have essentially the same net worth as the first situation, but you control more assets and have more financial flexibility.

[Texas Eagle]

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.

That's what we did. We had our loan officer print out the numbers for a 30 year loan at 5.75% and a 15 year loan at 4.75%. Then we had him figure out the monthly payment broken down by prinicipal and interest.

We discovered that even with the lower rate for the 15 year loan, we would save tons of money that would otherwise go to interest by going with the 30 year loan and make the 15 year payments.

[AZHSer]

We started in 94 with a rate over 7%. We refinanced 6 years later to 6.5% and dropped our payments by $100. Since we weren't used to having the extra cash we continued to to pay that $100 towards the principle. We also saved and paid an extra $1000 toward the principle a year. Last year we refinanced again to 5.5 with a 15 year loan and continued to put an extra $100 on it. If all goes well, we should be done in another 7 years. It is well worth it to refinance. Even if you just take out a 30 with a lower rate and continue making the old payments, the savings are fantastic. The secret is putting extra on the principle, even if it is just $10 a month.

[Joe Hadenuf]

My bet is that mortgage rates will be dropping even further. If they start raising interest rates anytime soon, during this economy, they will only make it worse.

[Skywalk]

The financial advisor, Rick Edelman(IIRC) advises AGAINST short-term mortgages, making extra payments or trying to "get rid of a mortgage."

His philosophy is that because of people having their homes taken away from in the Depression that it's become a part of the culture to fear foreclosure. Problem is, the law is different, the bank can not call in what you owe before it's due. Essentially, people are wasting their money by trying to get rid of debt and also mistakenly believe that their house is their best investment.

Like Edelman says, it's just a place you live in(Unless you're heavy into real estate.)

[Joe Hadenuf]

And that's exactly what many did after being burned by the stock market, they put their cash into RE.

[Texas Eagle]

The financial advisor, Rick Edelman(IIRC) advises AGAINST short-term mortgages, making extra payments or trying to "get rid of a mortgage.

I wonder what Rick's problem is? If a person pays only the required monthly payment on a 30 year mortgage, at the end of that 30 years, he will have paid at least double the selling price.

By making extra payments on principal, and shortening the life of the loan, he will save tens of thousands of dollars that would otherwise have gone to interest.

Whatever tax advantages you lose by paying off a mortgage is more than made up for by saving on what otherwise would have gone to interest.

[LizardQueen]

We went to 15 years at 6.625 just a year after we bought the house (original mortage was 30 years at 8.25) - this was in 1992, right around the time of the last recession.

We haven't bothered to refinance since according to the amortization chart we are paying almost all principle at this point, and it's not worth the refi charges with only 4 years left on the loan.

I LOVE being almost paid off. I know there are tax advantages to paying a big mortgage, but I really hate feeling like I'm living on the ragged edge of losing the house with a job loss. We're getting killed on taxes, though - didn't have enough mortgage interest or property tax expenses to clear the standard deduction last year.

We are going to take out a home equity to replace the siding sometime this fall, but we DON'T use it for anything else. We even save up and pay cash for cars.

LQ

[Skywalk]

I think it's because the MONTH TO MONTH cash you're spending on making extra principal payments could go to investments of various kinds that would earn one a net gain at the end of that 30 years.

Basically, thousands upon thousands of dollars properly invested can be a million or two million at the end of 30 years. By paying the mortgage more quickly or just bringing principal down, you are left with a damn house.

It would depend on how much loot one has. If I were incredibly wealthy I'd just buy without worry because monthly payments would be irritating.

Rick also correctly points out that constant references to the "Dow Jones" paints an inaccurate picture of the entire stock market, sometimes too rosy and others too gloomy, as it is only a measure of the very largest.

Just read some of his book, so I'd have to re-check a few factoids.