More home buyers are choosing mortgages with shorter pay-back periods in an effort to reduce their interest costs, mortgage lenders say.
Shorter-term mortgage loans have become a booming business for many lenders in the past two years. Known in the mortgage-lending industry as "intermediate-range" loans -- and dubbed by some as "Yuppie mortgages" -- 15-year mortgages generally carry interest rates that are one-half to three-quarters of a percentage point lower than standard 30-year loans.
But some real estate experts caution that a 15-year mortgage may not be the best way to finance a house for many home buyers, despite the large savings in interest rates and mortgage interest a shorter-term loan can provide.
"They aren't for the first-time home buyer, because he will be reaching, stretching his budget to the limit to afford a house at all," said Warren Lasko, executive vice president of the Mortgage Bankers Association of America. "We are finding that it is more attractive to the middle-aged couple that may be moving into their second or third house and are putting down a large down payment, and want to own their home outright by the time they retire."
In a recent survey of 20 of the largest mortgage bankers in the country, the MBA found that one out of every six home loans today is a 15-year loan, "a very significant increase over last year," Lasko said.
The Federal National Mortgage Association, the federally chartered secondary-mortgage market company known as Fannie Mae, said that its business in 15-year mortgages is "up dramatically" from last year, and now totals $2.5 billion worth of home loans.
Despite the growing popularity of 15-year mortgages, industry analysts say the demand appears to be coming from people and institutions investing in mortgages and mortgage-backed securities rather than from home buyers.
"I think the demand for the 15-year mortgage is coming more from the investment community than consumers," said Jon Bray, vice president of Weaver Bros. Inc., a Chevy Chase mortgage banking company. "We've seen a tremendous shift to these products, because investors want to put their money in either whole loans or mortgage-backed securities that have a shorter life."
The growth of a secondary market for mortgages over the past five years has connected mortgage lenders with capital markets worldwide, and the investors in those markets are looking for investment vehicles that will protect them from the risk of shifting interest rates, experts say.
Secondary-mortgage-market companies purchase loans from lenders and then resell them as whole loans or in the form of mortgage-backed securities on the capital markets.
Because long-term loans, such as 30-year mortgages, are considered more vulnerable to interest rate changes than shorter loans, investors have actively sought shorter-term loans. This partly explains why interest rates on 15-year mortgages have crept downward over the past three years to a point now that they are more attractive to some borrowers than the standard 30-year loan.
Home buyers seem to like the savings in interest and the idea of paying off their loan in a shorter time.
For example, a $60,000 loan with a 13 percent interest rate paid back over 30 years will cost $238,939, of which $178,939 is interest.
The monthly payments for such a loan would be $664. If the home buyer was willing to pay $100 more a month, the loan would be repaid in less than 15 years, and the home buyer would save $103,000 in interest. A 15-year mortgage generally requires a monthly payment that is about 12 to 13 percent more than the payment for a 30-year mortgage.
Mortgage lenders say the kind of families that might be interested in a 15-year loan are those with two working spouses earning enough to shoulder the higher monthly payments, hence the term "Yuppie mortgage."
Lenders say they also see considerable interest from people at their peak earning power who need the interest deductions now for the tax benefits, but who might be retiring in the next 15 years and will not need the interest deductions after they stop working.
While the savings in interest are significant, consumers should be careful to review their entire investment strategy when considering a 15-year mortgage, said David Andrukonis, an economist with the Federal Home Loan Mortgage Corp., a secondary-mortgage-market company known as Freddie Mac.
"They aren't for everybody," Andrukonis said. "Essentially, taking a 15-year mortgage means you are buying less house than you can afford. Not everyone may want to do that."
For example, a standard 30-year, fixed-rate $100,000 mortgage today would come with an interest rate of about 12 percent and require monthly payments of $1,029. A 15-year, $100,000 mortgage, which would carry an interest rate of 11 1/2 percent today, would require monthly payments of $1,169.
If a family could qualify for the 15-year, $100,000 mortgage, their income would be high enough to qualify them for a $113,600 mortgage amortized over 30 years, Andrukonis said.
"A lot of people are refinancing mortgages by going from a 30-year loan to a 15-year mortgage," said Dennis Campbell, vice president for marketing with Fannie Mae. "Because inflation has tapered off, the home buyer cannot count on inflation to increase the equity in the home, and people are interested in building up equity faster by going with a 15-year loan."
Campbell said, as a comparison, that at the end of making payments for 10 years on a 30-year mortgage, only 6 to 7 percent of the loan will have been repaid. At the end of 10 years of payments on a 15-year mortgage, 47 percent of the loan will have been repaid.
Andrukonis said home buyers should consider that the extra money going to the increased payment means losing the opportunity to do something else with that money.
"You might be able to invest that money in something else, rather than pay off your mortgage faster," Andrukonis said. "It means that you are building up the equity in the house faster, but you have to ask yourself where that gets you. It may not be worth it."
Andrukonis said he believes the shorter-term loans have become more attractive because it is easier today to borrow against the equity in a house than it has been in the past.
"In the past, equity built up in a house was hard to tap unless you moved, and second mortgages were very expensive.Today, people can go out and borrow against the equity in their house to buy a boat or put on an addition at much lower rates. That removes one disincentive with the 15-year mortgage," he said.
Some lenders, particularly those trying to close out old mortgages that have low interest rates, have sent out letters to people who already have 30-year loans telling them they can convert their loan into a 15-year mortgage by increasing their payments.
Industry experts caution consumers to question whether it is really in their best financial interest to pay off a below-market-rate loan early by increasing monthly payments.
"If a lender offers that, however, consumers should be sure to negotiate for a lower interest rate than they have on their 30-year loan," Lasko said. "Shorter-term money should always have a lower rate than longer-term loans."
Lenders also cautioned consumers that making additional payments to reduce the principal balance of their mortgage, done at the discretion of borrowers, may be easier for the borrower but will not reduce the interest rate, as would a commitment to increase all monthly payments through converting a 30-year loan to a 15-year mortgage.
Some lenders also are offering a new type of loan called the biweekly mortgage, a concept that allows the borrower to pay off the mortgage in 18 to 19 years. A biweekly mortgage requires 26 payments a year, the equivalent of making 13 monthly payments instead of 12.
This type of mortgage has been attractive to people interested in increasing their equity quickly and paying off the loan earlier. Similar to the 15-year mortgage, biweekly mortgages also substantially reduce the amount of interest.
Interest rates for biweekly mortgages, however, are generally slightly higher than for 30-year loans, because of the additional accounting burden of processing 26 instead of 12 payments a year.
"Operationally, everything in the lending business is set up for 12 payments a year, from computer software to accounting sheets," according to a Fannie Mae spokesman. "It would take a tremendous amount of adjustment in the systems to accommodate these loans, and for that reason they are not expected to become widely accepted."