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."

[speekinout]

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?

Idjit.

[AdamSelene235]

fyi

Bummer for Fannie's bondholders, huh? Hope they hedged the pre-payment risk properly.

[Southack]

The phrase "pre-payment risk" is an oxymoron; when someone pays off their loan early due to a pre-payment, there is no risk. You've (the bank / person who loaned out the money to the borrower) got ALL of your principle back PLUS all of your interest to date as well as ALL of your fees (fees which would have normally been budgeted to cover a much longer time-frame, in fact). Moreover, you or someone else is making NEW money on the new fees for the re-finance/pre-payment.

Sure, you might be getting less overall interest, but it is a FACT that you are getting more in fees as well as 100% of your original principle back.

Ergo, no "risk".

It does give me a good chuckle though when I hear someone claim that getting your money back early is a "risk", though!

[Dec31,1999]

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.

Actually, the return effectively exceeds the mortgage rate, as money not earned cannot be taxed.

[rwt60]

Is it really wise to make investment decisions based on today's tax law?

That's a good point. The standard deduction for married couples just went to $9,500. Once you add your mortgage interest to your other itemized deductions, you have to exceed the $9,500 threshhold before you reap any benefit from mortgage interest, and then only by the amount your total deductions exceed standard. In my opinion, the value of a mortgage interest deduction is overstated. Your mileage may vary depending on your tax bracket and filing status.

[Dec31,1999]

Better said: Money SAVED cannot be taxed.

[AdamSelene235]

It does give me a good chuckle though when I hear someone claim that getting your money back early is a "risk", though!

When debt to equity is 60 to 1 and you have an enormous illiquid derivatives hedging operation EVERYTHING is a risk.

BPT is doing great, as is DOM, PWI, and PVX. DOM is a personal favorite of mine simply because it is a local Alabama trust based upon abandoned coal mines along the Warrior River basin. By injecting water, the coal seams produce natural gas in marketable quantities, earning a nice 10% dividend check for its shareholders (something that every BPT owner can likewise appreciate). Who would have thought, some 20 years ago, that there was real money in abandoned coal mines?!

Life is good!

And even a gloomster can justify owning them as an inflation hedge.

Life is not utterly unbearable!

[Texas Eagle]

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

I'm sure my bank wants me to think the same thing.

[cookcounty]

Wow. 15 months ago I refinanced and asked about a 10-year, but all the banks acted like I was speaking Khirghizian, basically told me there wasn't such a thing.. Maybe I should try again, but the process of re-fi is such a pain, and then they sell your mortgage---I had 4 banks in the first 7 months, which has finally stabilized (for now!).

[E. Pluribus Unum]

Idjit.

Instead of paying $125,000 interest on my loan over 30 years I am going to pay $30,000 interest in 9 and be free and clear and you call me an idiot.

I bet your related to that banjo-playing, albino hillbilly in "Deliverance."

[E. Pluribus Unum]

...but the process of re-fi is such a pain, and then they sell your mortgage...

Countrywide's rates are as low as anybodies, and they don't sell the paper. They make it very easy to make accelerated payments, also.

[Atlas Sneezed]

"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?"

If you invest the difference in payments every month, you will have a fat nest egg for all these things.

[E. Pluribus Unum]

If you invest the difference in payments every month, you will have a fat nest egg for all these things.

Unless the market implodes just about the time you need it.

Not that that would ever happen. </sarcasm>

[sysvr4]

Unless the market implodes just about the time you need it. Not that that would ever happen.

And I'm sure you can name for us, very specifically, the 30-year time period during which the market "imploded", yes? Hell, name for me the 30-year period where the market didn't beat the annual effective rate of 3-4% you can borrow money at now...

Jeff

PS - Hint, there was never any such period. The market is positive for EVERY 20 year period in its history.

[speekinout]

OK. As I have said before, if you have plenty of money, then having a bunch in your house is probably no big deal. But if that is most of your net worth, you are just a short time from trouble.
Everyone needs a ready cash stash for health care or a jobless interval or whatever. That's much more important than equity.

[Timmy]

You better look again. The rates for a 10 year mortgage are about 4.75. That has to be a big payoff for you. BTW, I just went to a 10-year mortgage.

[griffin]

"How do you feel about borrowing money at 5% and receiving capital losses of 10%? That's far more more likely than any kind of gain. Or 50% losses? Not at all out of the question. The banks aren't paying .02% interest on your savings accounts for no good reason."

You're daffy. If you think that a long term investment in a respectable mutual fund will not gain you a better return than you pay out in a low interest rate mortgage...well...you just have a lot to learn. Over the course of 30 years, a nice 10% return is conservative. To take fund performances of the last two years and use that as a basis for argument is naive and frankly, silly. One would have to be pretty dense not to borrow money at 5% and use it to gain returns at 10%....afterall....how do you think BANKS make money?? Same principle. But...do whatever you want.

As for me...I'd borrow all I could against my house to invest in a decent performing index fund for the long haul. Cheap money.

[jehosophat]

Daschle is deeply saddened!

[FreeperinRATcage]

I would...but I no longer have A credit (sigh).