Mark your calendars. The Van Ripers have moved up the date of their mortgage-burning party. When the couple purchased their St. Paul home in 2005, they locked in a 6 percent interest rate for 30 years. But with mortgage rates at jaw-dropping lows, they were able to refinance into a 4 1/8 percent, 15-year mortgage that will save them more than $100,000 in interest and allow them to pay off the mortgage by the time their 3-year-old son is in college. All this for a $100 increase in their monthly mortgage payment.
Shorter-term mortgages are deliciously low. Last week, the average rate for a 15-year fixed-rate mortgage was 3.83 percent with an average 0.6 point (a point equals 1 percent of the loan value), according to Freddie Mac. The rate on a 30-year, fixed-rate mortgage wasn't much higher, weighing in at an average 4.35 percent with an average 0.7 points paid.
Refinancing to a shorter-term mortgage if you can afford the payment seems like an obvious smart-money move. You'll pay far less in interest, get rid of the monthly fixed expense earlier, and have freer cash flow in retirement. Plus there's the high that homeowners feel when they imagine making their last mortgage payment.
"It's just nice to think it's going to be done," said 33-year-old David Van Riper.
But there's a camp out there that believes locking into a shorter-term mortgage is unwise, especially when rates are so low on 30-year mortgages and economic uncertainty so high.
When Kevin McKinley, a Wisconsin financial planner and co-host of Wisconsin Public Radio's "On Your Money," learned I refinanced into a 15-year loan, he e-mailed me a list of reasons why I shouldn't have. His primary concern? That I've locked myself into higher payments at a time when the job market is shaky and home equity is tougher to access. "It's about having the cash right now and being able to do what you wish instead of being at the mercy of the bank, or the real estate market if you have to sell, or your own job," he said.
McKinley would have refinanced into a 30-year loan and stashed any money freed up by the lower payment in a savings account or CD.
I could also have taken the excess and put that money to work in the stock market or even in bonds. Considering my mortgage interest rate after the tax deduction is in the 3 percent territory, it wouldn't be hard to beat that in the market. But that's not a sure thing. "Given the recent variations in the stock market and whatnot and the low interest rate in savings, it just seemed to make sense to put it into the house," Van Riper said.
'Self-insurance'
Alex Stenback, a mortgage banker with Residential Mortgage Group in Minnetonka, said this difficult economic stretch has brought out the conservative side in most of us.
"When savings rates go up, when people start talking about 15-year mortgages or paying their mortgages off ahead of schedule, that's really just a form of self-insurance. They're no longer as comfortable with the fact that the sky's the limit and the ladder goes up for them economically," he said.
Anticipating your financial future is hard, but that's exactly what Bill Schwietz, president of the Minnesota Mortgage Association, tries to get clients to do when choosing between loans. He's seen several friends who started with 30-year mortgages, then refinanced to 15-year loans with a big promotion and then refinanced into a 30-year loan again when their children's hockey fees and private school tuition became too much.
Problem is, if you lengthen your loan and roll in closing costs with each refinancing, you'll never pay down the principal.
Kate Wilson, branch manager for Fairway Independent Mortgage in Bloomington, said 15-year loans can certainly make sense. But she always reminds her clients that there's no law against paying off a 30-year mortgage on a 15-year schedule. You'll still save a boatload, even if your rate on a 30-year mortgage is half a percentage point higher than a 15-year would have been.
Here's the example she calculated: On a $200,000, 30-year mortgage at 4.5 percent, you'll pay $164,813 in interest with a monthly payment of $1013.37. Pay down that loan in 15 years (by making prepayments of about $517 per month on the mortgage balance) and your monthly payment would be $1,529.98 and you'd pay $75,396 in interest. If you went with a 15-year mortgage at 4 percent instead, you'd pay $66,286 in interest and have a payment of $1,479.37.
So ask yourself if you'd be willing to pay a few thousand dollars more in interest for the flexibility of having an extra $500 a month to cover life's expenses without tapping home equity. Also assess whether you're disciplined enough to actually prepay the loan. If the answer is no, then a shorter-term mortgage is a good fit, provided you can truly afford it.
Most mortgage bankers, including Wilson, have calculators on their websites. The local financial calculator site dinkytown.net has several calculators to choose from, including a 15-year vs. 30-year mortgage calculator.
No-equity options
Of course, there's that little problem of declining home values that's making it hard for people who put little money down or bought at the peak to refinance. But having little equity doesn't slam the door. Borrowers with an FHA loan can reduce their rate without an appraisal using the FHA streamline refinance option if they meet the requirements, which include paying the mortgage on time, having income and meeting the minimum credit score requirements set by their lender (generally around 640 these days, Stenback said).
There's also the government's Home Affordable Refinance Program as well as the recently launched short refinance program for non-FHA borrowers who are underwater. Learn more about both options at www.hud.gov.
Even if your current circumstances lock you out of a refi, there's nothing stopping you from prepaying a longer-term mortgage. Make an extra payment on your 30-year loan each year and you'll retire it approximately seven years earlier.
"That's a huge pile of money," Wilson said.
Kara McGuire • 612-673-7293 • kmcguire@startribune.com
