Homeowners taking out 10-year mortgages

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."

I had no idea this would turn into such a great thread when I posted the article. There are lots of intelligent people at this forum, and even though there is some disagreement over the best course of action, the contributions on this thread have been excellent.

"If I lose my job while I still owe on my house, I absolutely HAVE to come up with 1,000 dollars plus whatever I HAVE to come up with for food, electricity, etc.

"If my house is paid off and I lose my job, I have 1,000 dollars LESS to worry about, don't I?"

You forget that in the big-mortgage scenario, you were saving the monthly difference in house payment, so you have a fat nest egg to tide you over until you get a new job. In fact, if you would have paid off the home in your approach, the nest egg would be fat enough to pay off the whole mortgage in the Edelman scenario. Read the Edelman story.

"Then, ask him to print out a report on how much interest you would pay if you got a 30 year loan and made the 10 year payments."

Looking only at total payments is an economically naive approach that emotionally and irrationally ignores the time value of money.

If you must do this, also have your broker put together a scenario of what the monthly savings (with the long-term loan's lower payments), would yield when invested over the same period. If you ignore this, you miss Edelman's entire point.

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.

If your retirement income is allocated to mortgage payments you won't have much left over for house upkeep, emergency medical bills, buying an occassianal car and taking vacations, will you?

"Their $8,000 house would probably sell for $70K or $80K - almost 10x what they paid."

10x in 34 years? That's a 7% annual appreciation rate. Nice, but not stunning, and less than the stock market would have done for them. They would have profited by keeping their equity low, refinancing when rates were good to pull out equity as it grew, and investing in the market. (A six-figure cash nest egg is more to brag about than a $95 mortgage payment.)

"It's hard to imagine the same thing happening with current prices. Will my $200K house be selling for $2 million in 30 years? It boggles the mind...."

What annual rate of appreciation do you expect?

"Get out of debt. Get out of all debt. Especially debt on your home. This was the standard procedure 50 years ago, and it is just as vital today. Anyone who tries to convince you that you are better off being in debt is just a snake-oil salesman trying to get rich quick off of your hard earned dollars."

You should read what Edelman says to debunk this.

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.

You don't have to reduce the term of the loan to save money on the interest. You can take out the 15 year loan and then make extra principle payments when you can afford it. The interest savings effect is the same. The shorter term will sometimes come with a lowere interest rate, but not always.

I took out a 15 year mortgage at 6.5 in 1999 and paid ahead. That put me on track to pay off in 7 years this year. But when interest rates dropped to below 5, I refinanced for another 15 year period at 4.8% (0 points) and dropped my payments by $300 a month. The overall interest went up for the life of the loan, but with compound interest on $300 additional savings dollars a month, I come out ahead. Plus, I can still pay ahead on the loan if I want to rid myself of debt in 8-10 years instead of putting the money into investments. That's the good thing about it, the choice is there.

I don't know about demolishing it but I am sure that in the new tax cut Bush has made PMI tax-deductable.

I believe that the PMI deduction was removed from the final version of the bill.

bump

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.

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.

This Gloomster sez:

</booming voice on>

This will hurt the the thinly capitalized GSEs who hold more debt than the publicly held Treasury debt!

Should they destabilize their counterparties will experience contagion via their 1 trillion dollar derivatives portfolio.

GLOOM ! DOOM ! BOGETY BOGETY BOGETY....MUHAHHAHAHHAHA

Speaking of hedging your bets against the possibility of losing your job: how about taking out a revolving line of credit guaranteed by your mortgage while you're employed, DON'T TOUCH IT (unless you're able to pay it off before interest starts accruing), and keep it as a safety net against it. You're already qualified, and it will be there in the event of a between-job-drought.

Hmmm, lots of assumptions.

Housing prices go up
Dog Gone and I know this is false.
Long term the stock market goes up.
What if you need your money during a downturn?
Mortgage interest is tax deductable
Is it really wise to make investment decisions based on today's tax law?

As long as you only refi the existing balance, you're ok. From what I understand, a lot of people are "taking" the extra equity. Sounds like you're doing it right.

btw - thanks for posting this thread, I'm looking into this as we speak. I just bought a new home, so it's mighty tempting...

One of things I did was to take a small loan against my 401(k) to put more money down on the house to allow for lower monthly payments - I believe in the first few years of a loan "flow (cash flow) is king". I was able to bail out of the equity based mutual funds in early 2000, so I retained the gains made in the 90s, which made this possible. Plus the interest I pay on the loan gets paid back to me, instead of some finance company. I know some people object to borrowing against a 401(k) and they correctly state that you lose the compounding effect when you borrow, but I believe short-term 401(k) loans.

"taking out a revolving line of credit guaranteed by your mortgage while you're employed, DON'T TOUCH IT "
---

Any credit line can be canceled at any time by the creditor for no reason. The only real security is the money in hand. I've known of people who had credit lines, never missed payments, and still had credit lines closed, just because they borrowed more ( NOT over limit, just multiple cards) then the credit card company thought was reasonable. E.g. supposed you have a total of $40K credit lines, for whatever reason, you actually start using them and borrow up to say $20-$30K. Technically you have another $10K, except that credit card company takes one look at how your balances are increasing, closes your credit line, and there you sit, you can't borrow the other $10-$20K, even though you thought it was there for you for a rainy day.

The only real security is to take out the biggest mortgage at low interest rate on your house, very carefully invest the rest (diversify to ensure safety), then it's there for you, when you need it.

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.

Not quite the same. Your mortgage payment is - or at least should be - an affordable part of your retirement income. It's not going to change. The important thing about retirement budgets is having fixed costs.
A significant part of your net wealth should be money that you can get if you need it. And if most of your wealth is in equity in your home, you could be in trouble.

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