For most of the past half century, buying a home typically meant dutifully adopting a 30-year, fixed-rate mortgage loan. But this has not always been the case, as the standard 30-year loan became common as a means to encourage more widespread homeownership in the aftermath of the Great Depression. Loans of such duration were only possible with the emergence of the government as a guarantor, since banks are typically reticent to extend terms so far into the future.
Christopher HopkinsWhile certainly promoting expanded ownership, these loans also encouraged speculation and have cost borrowers trillions of dollars in interest expense. By late 2006, the combination of easy loan terms, Federal guarantees, rampant speculation and financial engineering led to the biggest economic collapse since said Depression, leaving millions of homeowners either under water or dispossessed of their homes. We are only now recovering from the carnage, and slowly at that.
In response to the financial crisis, Central Banks have relentlessly lowered interest rates in an effort to stimulate more robust economic growth. While the results have been decidedly mixed, there is no doubt that homeowners are being offered a once-in-a- lifetime opportunity to substantially improve their balance sheets by shortening the length of their mortgage terms from 30 to 15 years.
Oddly, data from the U.S. Bureau of Labor Statistics suggests that homeowners have been doing the opposite.
Each quarter, the BLS contacts a representative sample of households to gain additional insight into the macro data collected on the economy. One series of the survey monitors the length and terms of any mortgage loans held, and the results are surprising. In 2006 at the onset of the mortgage crisis, 48 percent of home loans were standard 30-year fixed rate mortgages, while 14 percent were 15-year loans. Fast forward to 2014, and 71 percent of all mortgages were of the 30-year fixed variety with 15-year loans still around 14 percent. The difference came from non-traditional loan types like adjustable-rate and balloon payment loans. Homeowners have clearly locked in lower rates, but have not taken the opportunity to shorten up on payoffs.
If you are in that category, now is the time to seriously consider taking the plunge. While mortgage rates have ticked marginally higher in recent months, they are still hovering near historic lows. But this will not hold forever, and pressure is mounting on the Federal Reserve to begin the process of raising rates.
Consider the impact on the family finances of moving up the repayment schedule. Let's take a home in Tennessee listed for $180,000 (the median according to Zillow). Net of a 20 percent down payment, we will finance $144,000.
Borrowing for 30 years at 3.625%, you will be obligated to make principle and interest payments of $657 per month for the duration (360 monthly payments).
Now consider the 15-year rate of 3.00%. Monthly P&I payments will run you $995 per month, clearly higher than the longer term loan. But consider the savings: shortening the payoff period means you will save over $57,000 in interest expense over the life of the loan, and own it outright in half the time.
It has never been so critical that families plan to pay down their mortgage in the shortest possible time. With the demise of the traditional pension plan, each of us bears the full burden of saving for retirement. Meanwhile, government figures suggest that half of us lack access to a retirement plan at work, and nearly a quarter have no savings at all. Knocking out that mortgage and owning your home is a key to a more secure retirement, and the opportunity is now.
Christopher A. Hopkins is a vice president and portfolio manager at Barnett & Co.