Should You Switch to a Shorter-Term Mortgage?

Posted by cskadmin on September 20, 2012

A growing number of homeowners are switching to shorter-term mortgages. Rates on 15-year mortgages are at all-time lows, and the differential between 15-year rates and 30-year rates is greater than ever.

It wasn’t that long ago that a 15-year mortgage was considered a fringe product, suitable for a relatively small number of buyers and homeowners looking to refinance. But no longer. In fact, according to Freddie Mac, almost one-third of all mortgages refinanced during the first quarter of 2012 replaced their 30-year mortgage with a shorter term loan.1

The trend toward shorter mortgage terms stems from several factors.

  • Debt reduction. Many households are looking for ways to reduce their debt, especially in light of the drop in house prices, which has left nearly one-quarter of American homeowners under water with their mortgages.2
  • Low rates. Rates on 15-year mortgages are at all-time lows, and the differential between 15-year rates and 30-year rates is greater than ever. According to Freddie Mac, the average rate for a 15-year mortgage, as of August 23, 2012, was 2.89%, compared with 3.66% for the average 30-year mortgage. That’s a 77-basis-point difference. Historically, this spread has been much smaller, averaging 48 basis points for the 20 years ended December 31, 2011, and as low as 31 basis points as recently as 2007.3
  • Earlier payoffs. Perhaps most alluring for consumers is the prospect of paying off their mortgage sooner — and saving thousands in interest payments in the process. For example, on a 30-year, $100,000 mortgage at 4%, you would pay $71,870 in interest over the life of the loan, while a 15-year mortgage of the same amount and rate would cost you only $33,144 in interest — a savings of more than $38,000.

The downside to 15-year mortgages, however, is that your monthly payment can be significantly higher because of the additional principal you are paying each month — averaging twice what you would pay on a conventional 30-year mortgage. For many, the extra payment is simply not doable. But for those who can afford it, the long-term savings are significant.

Whether you go with a 15- or 30-year mortgage, remember to factor in points and closing costs. Also consider how long you expect to own the property. Your bank or mortgage representative can work with you to weigh different mortgage options and help you decide whether a 15-year mortgage is right for your situation.
1 Source: Freddie Mac, July 2012.
2 Source: CoreLogic, as of the first quarter of 2012.
3 Source: Freddie Mac, Primary Mortgage Market Survey, August 23, 2012.

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