published Wednesday, August 6th, 2014

Personal Finance: Good news on home mortgage debt

Chris Hopkins

The 2007 financial crisis marked a painful denouement to the epic story of excess in the U.S. housing market. Millions of homeowners found themselves heavily indebted for an asset that had declined in value or even slipped under water. But today there is good news: more families are taking decisive action to reduce debt by shortening their mortgages.

According to Freddie Mac's quarterly report on the home loan market, the post-crisis wave of refinancing has included a large number of borrowers who traded into shorter term loans. In fact, four in 10 homeowners who refinanced during the second quarter of this year chose 15- or 20-year fully amortizing mortgages, the highest percentage since 1992. This salubrious trend has already had a positive impact on household balance sheets.

There has seldom been a better time to get a shorter loan. Not only are absolute rates near all-time lows, but the spread between longer and shorter maturities is exceptionally wide. Borrowers can currently save almost a full percentage point by dropping the old 30-year mortgage and embracing a 15-year note (moving from 4.30 percent to 3.36 percent on average). This confluence of beneficial forces for homeowners is temporary, so borrowers who have not taken advantage should seriously consider getting in on the action before the buzzer sounds.

The concept of a mortgage traces its origin to antiquity. Borrowers pledged their property as collateral for a loan to purchase the asset, which expired or died when the debt was paid. Hence the word mortgage from the Latin "mortuus," the death of the pledge as the loan was "amortized" or killed off.

Until the Great Depression, mortgages typically ran five to 15 years. The 30-year loan was the brainchild of the FHA in 1934 and exists only in the United States. Most other developed countries limit home loans to 15 or 20 years at most. As the longer term became customary, and as lending standards relaxed, home prices naturally inflated beyond sustainable levels and the painful correction ensued.

The financial crisis and its sobering aftermath have prompted many families to rethink their debt profiles and reduce their leverage. This is especially healthy in the area of home mortgage debt. Traditional 30-year mortgages mean many thousands in additional interest expense over the life of the loan.

Take the example of a $200,000 mortgage at 5 percent over 30 years. Monthly principal and interest payments of $1,075 result in $186,000 in interest expense out of your pocket into the bank's. Refinancing into a 15-year loan at 3.4 percent produces a $1,420 monthly principal and interest payment but saves you a whopping $130,000 in interest. Think that might help in retirement? Not to mention the benefit of owning your pad free and clear when you accept your gold watch.

If your current loan balance is more than the value of your home, options are more limited. But if the loan is guaranteed by either Fannie Mae or Freddie Mac, you may still qualify to refinance through the much-improved federal HARP program. You can contact either agency by phone to determine eligibility. And even of you do not qualify, some banks have agreed to voluntary programs to assist underwater borrowers with good credit histories. Reach out to your current lender for more information.

Household debt reached alarming levels in the lead-up to the financial crisis, but the tide is turning. Homeowners are again building equity thanks in part to lower rates and smart decisions to shorten their loans. If you haven't yet taken a look, don't wait too long.

Christopher A. Hopkins, CFA, is a vice president for Barnett & Co. Investment Advisors.

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