Paying Less for a Mortgage

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Original Post Date: November  9, 2012

By: Ruth Simon

Mortgage rates have flattened out, but some borrowers are lowering their rates further by opting for a loan with a shorter term or taking out a “hybrid” adjustable-rate mortgage.

Wells FargoWFC -0.77%the nation’s largest mortgage lender, says one-quarter of its borrowers are choosing 15-year loans. Freddie MacFMCC +4.10%the government-controlled mortgage company, says about 30% of borrowers this year have opted for shorter-term home loans when they refinance, with most picking a 15-year mortgage.

“You can save as much as three-quarters of a percentage point by going with a 15-year term as opposed to a 30-year term,” says Freddie Mac chief economist Frank Nothaft. Shorter-term loans are particularly attractive to people “who have been homeowners for a number of years…or who want the security of knowing they will own their home free and clear when they retire,” he adds.

David Wimer, who lives in Bolton, Conn., recently refinanced the mortgage and home-equity loan on his 3,000 square-foot Colonial into a new 15-year mortgage with a 2.875% rate. “I’m 49 and I want to try and get it paid off around the time I am retiring,” says Mr. Wimer, a real-estate attorney. Many of his clients are switching to a 15-year mortgage as they refinance for the second or third time, he says.

Rates on conforming 15-year fixed-rate mortgages currently average 2.99%, according to mortgage research firm HSH.com, well below the 3.47% average rate on 30-year fixed-rate ones. Rates currently average 2.87% on hybrid ARMs that carry a fixed rate for the first seven years and then adjust annually, though borrowers could face significantly higher costs once the fixed period ends.

Choosing a shorter-term loan can mean a significant drop in interest charges over the life of the loan. A borrower would pay a total of $82,646 in interest on a $350,000, 2.92% 15-year fixed-rate mortgage, according to HSH.com. On a $350,000, 30-year mortgage with a 3.57% rate, the borrower would pay $220,730 in interest.

Because it gives you less time to repay your loan, a 15-year mortgage isn’t for the cash-poor. The monthly payment on the $350,000 loan with a 15-year term would be about $2,404, according to HSH.com—much more than the $1,585 payment on the 30-year fixed-rate mortgage.

Your mortgage-interest tax deduction also will be smaller with a 15-year loan instead of a 30-year loan, in part because “each payment is more principal and less interest,” says Donald Williamson, executive director of the Kogod Tax Center at American University.

The sticker shock is likely to be smaller if you are refinancing a mortgage that you have been paying down for some time. “If you’ve had the loan for five to eight years, the payment is typically the same or goes up $100 or so,” says Michael Menatian, president of Sanborn Mortgage in West Hartford, Conn.

Before opting for a 15-year mortgage, borrowers should consider whether they have other pressing financial needs, such as building an emergency fund, saving for retirement or financing a child’s college education. A 15-year loan also might be a risky choice if you are worried about job security or the stability of your income.

“Once you sign up for a 15-year payment, you are committed to that,” says Brian Wickert, president of Accunet Mortgage in Butler, Wis. Borrowers who want to repay their loan early can take out a 30-year mortgage and then make extra payments when they are able to, he says, though they won’t get the lower interest rate.

Some lenders now offer customized loan terms of, say, 18 or 23 years. Rates on loans with terms of more than 15 years tend to be close to the rates on 30-year mortgages.

Another way to lower your mortgage rate below 3% is to take out an adjustable-rate mortgage that carries a fixed rate for the first three, five or seven years and then adjusts annually.

The big risk of a hybrid is that you don’t move when you planned to and are stuck with rising loan payments. On ARMs that carries a five-year fixed-rate period, the rate can often rise by as much as five percentage points on the first adjustment. The total increase is typically limited to five or six percentage points over the life of the loan.

Still, hybrid ARMs can make sense for some borrowers.

Paul Patt, who lives in Brookfield, Wis., recently swapped a 3.875% 30-year fixed mortgage on his $750,000 home for an ARM that carries a 2.625% rate for the first seven years.

“My youngest child will go off to college in four years,” says Mr. Patt, a management consultant. “It makes sense for me now to go with an adjustable-rate mortgage to keep interest rates lower knowing that I will almost certainly be selling the home within the next several years.”

Hybrid ARMs also have found favor with borrowers taking out so-called jumbo loans—those too large for government backing. With a larger loan, a quarter-percentage-point rate difference “can be very significant in terms of your monthly payment,” says Jim Linnane, a senior vice president at Wells Fargo Home Mortgage. Banks typically hold jumbo loans in their portfolios, with many offering more attractive pricing for jumbo hybrid ARMs because these loans carry less interest rate risk for the lender than 30-year fixed-rate mortgages.

Before opting for a hybrid ARM, calculate how much your payments could rise if your mortgage rate increases by two or even four percentage points when the fixed period on the loan ends, says Keith Gumbinger, a mortgage analyst at HSH.com. “Before you sign on the dotted line,” he says, “it is important to know what you are getting yourself into.”

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