RateWatch #264 - Are 15 Year Loans a Good Idea?
August 18, 2001
by Dick Lepre
More bad news for the economy created the certainty of a Fed decrease and expanded concerns of recession or, at least, stagnation. Combined with CPI data showing no inflation, the week was a bleak one for equities and an excellent week for Treasuries, The 30-year Treasury closed the week at a yield of 5.41%. This has created a "second top" in prices even though we are in a technical bear market. It is not likely that we will get back to the low of 5.26% that we saw in March. A more likely scenario is that a Fed hike this coming week will cause selling and potentially terminate the bullish weekly cycle. This indicates that it would be discrete to lock rates in this Monday.
A most fortuitous confluence of lousy economic news with a bullish weekly technical has created another refi opportunity. The last time we entered a bearish long-term market we got no such break as the market fell straight down. This has created some great opportunities for refinancing.
15 year vs. 30 year loans
Often, when folks are refinancing they find that they have been paying on the mortgage for several years and don't want to get another 30 year loan. Refinancing, from this perspective, seems like a path to perpetual debt. One reaction is often: "Hey, why don't I get a 15 year loan? That way I'll actually own my house while I am still alive". Is a 15 year loan so much better than a 30 year loan?
The answer is most certainly open to debate but I think that the answer is, probably not. I think that the disadvantages usually outweigh the advantages. The only real advantage of a 15 year loan is that it has a lower rate. If you pay the loan off in 15 years you will pay a lot less total interest. That fact is indisputable but is it really advantageous?
The disadvantage of a 15 year loan is that it requires a much higher payment than a 30 year loan. My experience is that many people who can qualify for a 30 year loan cannot qualify for a 15 year loan. This implies, to some extent, that they may not be able to afford it. A payment that seems OK today could prove to be a disaster as times get tough and you have to scrape by to make your mortgage payment. You might find that just when the mortgage payment is getting oppressive you cannot refinance to a 30 year loan because of credit or income problems.
But What About All That interest?
Still, you are paying a lot more interest over the life of the loan with the 30 year loan right? Maybe, maybe not. For one thing, it is hard to borrow money at a lower rate than the mortgage on your principal residence. Why not lock in that rate for 30 years rather than 15? It is not far-fetched to suggest that the average person could get a better than 7% return on those dollars.
The other thing is that your Uncle Sam is helping you by making the interest tax deductible. In effect the 7% may be more like 4.5% "after taxes". One common analysis is to consider the options of getting a 30 year mortgage and investing the difference between it and a 15 year mortgage into a 401-K. A fair comparison is to compare what the balance in the 401-K account would be compared to what you would have if you put nothing into the account for the 1st 15 years and then start putting the entire payment into the 401-K for the next 15 years.
In one scenario reported in The Seattle Times a borrower with a $150,000 loan who put the extra into a 401-K would have$1.17 million in the account after 30 years. Using the 15-year plan he would have $791,000 30 years later. This, of course, assumes that one has the discipline to do this. If you have not the discipline to save and can afford the 15 year loan then perhaps the 15 year would be better for you. The harsh fact is that folks lacking discipline often have other problems (debt or credit) making a 15 year loan a problem with underwriters.
The Real Difference
This entire discussion assumes that the rate on the 15-year is better enough than the 30-year to make a difference.
At present, the difference between the 15-year conforming and 30-year conforming is 0.5%. That difference offers some attraction to the 15-year. The difference between the 30-year jumbo and the 15-year jumbo is only 0.25%. That minimizes the advantage of a 15-year loan.