Generally, the shorter the term on a fixed-rate mortgage, the lower the interest rate on the mortgage. This is because there is less interest rate risk for the lender; the shorter the term, the less time there is for interest rates to turn against them (go up).
The most common mortgage term lengths are 15 years and 30 years. However, some people nearing retirement are refinancing to mortgages with only 10-year terms. A month ago (June 2013) the national average for 10-year mortgages was 3% with 0.2 points. Some smaller community banks were quoting rates as low as 2.375%!
Bargain basement no more?
I chatted with a friend at work whom I thought had decided to rent his old house like I did. Turned out he hadn't; part of the reason was that interest rates have gone up quite a bit from a month ago. They're still really low historically, but not quite the no-brainer bargain basement rates that they were.
I found a site that looks at 10-, 15-, 20-, and 30-year mortgage rates. (Many compare only 15-year, 30-year, and a few ARMs.)
I took the average rate for each category, and crunched a few numbers on each for a $100k mortgage. Also, for fun, I put in a column for the option of no mortgage (100% cash down):
| Term | Cash purchase | 10-year fixed | 15-year fixed | 20-year fixed | 30-year fixed |
| Rate (as of 7/19/2013) | N/A | 3.20% | 3.42% | 4.10% | 4.39% |
| Monthly Payment | $100,000.00 | $947.87 | $710.96 | $611.26 | $500.17 |
| Interest Paid as % of Principal | 0.0% | 17.0% | 28.0% | 46.7% | 80.1% |
| Time before paying more principal than interest | What interest? | At Once | At Once | 3 years, 2 months | 14 years, 4 months |
Some observations:
- 10-year rates on average are slightly better than 15-year rates, but not much. Actually, from top to bottom, the range of rates from 10-year to 30-year is less than 1.2%, which is tiny. Unless the 10-year payment amount is really easy to make, it may be worth considering getting a 15-year mortgage, and accelerating the payments by paying the 10-year mortgage payment. (In other words, pay $947.87 rather than $710.96 on a 15-year mortgage.) This will pay off the mortgage in 10.5 years, which isn't a whole lot longer than 10 years. Plus, there will be the flexibility of dropping the payment about $235/month if times get tougher. With a straight 10-year mortgage, the payments couldn't be dropped without negative consequence.
- The 10-year payment is less than twice the 30-year payment. This is one way of showing the savings of going with a shorter-term mortgage. The 10-year payments are less than twice the amount of the 30-year payments, but you're only making a third as many payments (120 vs. 360).
- The amount of interest paid for the 30-year mortgage is almost five times that of the 10-year loan. For a $100,000 mortgage this difference amounts to over $63,000 over the course of the mortgage. (Granted, there is inflation to consider, but that won't make up the difference.) The lower monthly payment for the 30-year mortgage masks this difference very effectively, doesn't it?
- With the shorter-term mortgages, you're paying more principal than interest from the start. I have to admit: that's a good feeling! Of our two mortgages, the payment breakdown on the 15-year refinance we did a while back looks a lot nicer than the 30-year mortgage on our primary residence.
- Despite all of this, cash is still king. No monthly payment (save the really big one at the beginning, otherwise known as “paying in full”), no interest, no dealing with banks unless you want to for some reason. That, and cash negotiators could probably get the property for $90,000. 🙂
If you can swing a shorter-term mortgage, you can save money. The question is: How low are you willing to go? How high a payment is comfortable for you? That's something you'll need to consider carefully.
We came THIS CLOSE to going w/ a 10 year mortgage on our home, but at the time (3 years ago), the difference in rates was very, very small. Instead, we pay a little extra towards principal each month, and hope to pay off our 15-year in 10. Rock on!
Absolutely, NCN. It looks like the rate difference still is very small, though the WSJ article mentioned that some smaller lenders could offer really good rates because they were keeping the loans in-house. Probably if the loan-to-equity ratio is favorable enough, a 2.5% secured loan is pretty good. They make less than 1% when they buy bonds these days.
You know me, John, I never tire of the numbers. And I’m open to the good night’s sleep mortgage-free people claim to have. If someone has room in their budget and after seeing the cost of the 10 year mortgage payment, is still able to save for retirement and not use a credit card to pay for a car or home repair, I say go for it.
See that extra $447 (difference between 10 and 30 year payback)? What if that would have gone to a matched 401(k)? $894/mo into savings. 8%/yr return, $163K after 10 years. But. If the money would have gone down the drain, clothes for the closet, dinners to be made home at 25% the cost, etc, by all means, the faster payoff becomes money squirreled away instead of squandered. You offer a great way of looking at the numbers. Nice work.
OH! Very good! I totally neglected to talk about investing the difference. Having the smaller payment does indeed free up the money for use elsewhere. Furthermore, “elsewhere” can be “extra principal on the mortgage!” Paying extra principal results in a 4.39% return in the form of interest that doesn’t need to be paid back.
I was trying for a 5 year ARM! The adjustable rate doesn’t bother me since I am paying off my mortgage in less than 4 years. Unfortunately, my small balance (less than 50K) cannot get a low rate.
True; you can probably get some really low rates on an ARM. Rates for 5/1 ARMs have gone up recently (now they’re around 3%) but last year they were approaching 2%.