After an unbelievable decline to a record low on December 24, 2020 of 2.67% for a 30-year and 2.19% for the 15-year. For comparison, the 30-year was 18.44% on October 30, 1981 (now that’s a scary Halloween!). This article addresses some of the reasons we may see a rise in mortgage rates, but more importantly, why a 30-year may be better than a 15-year, or any shorter-term mortgage. To begin, have a look at this chart from the Fed and Freddy Mac:
The average 30-year mortgage rate from 1980 to 2021 was about 7.5%. If we ditch the high-inflation 20 years from 1980 to 2000, the average rate from January of 2000 to January 14 of 2021 is 5.09% for a 30-year and 4.5% for a 15-year. Here’s what the payment differences look like on a $202,284 mortgage, which is what Experian reports as the average mortgage debt in Q1 2019:
Two features become obvious: the current rates save over $100,000 in interest on a 30-year /$202,284 mortgage loan; and 15-year mortgages have a lot less interest. Borrowing at a low rate makes sense, but should you choose a 30 or a 15-year? The 15-year offers a lower rate, is there a reason to not choose a 15?
To answer that question, let’s have a look at some reasons rates may continue to rise. The Mortgage Bankers Association is predicting rates will be above 3% for 2021, and that almost 20 million people can benefit by refinancing. Rates could go up as a result of the profound Covid-19 pandemic stimulus packages and massive debt, or from inflation from commodity price increases. Corn was about $3.15 in June of 2020 and is about $5.36 mid-January of 2021. West Texas Intermediate Crude (WTI) was about $6.50 on April 21st, 2020 and is about $52.50 in mid-January 2021. There are similar price rises in copper, cattle, wheat and a plethora of other materials. Materials prices are an ingredient of GDP and as they rise as the world emerges from the pandemic, prices go up, and interest rates go up with them. Think how much oil, copper or food affect our daily lives. Rising prices bring inflation to the forefront. According to the Fed, the 10-year breakeven inflation rate was about 0.63% on March 17th, 2020. As of January 15th, 2021, it was 2.1%.
Why a 30 and Not a 15? Let’s get down to the central point of this discussion. 15-year mortgage rates are lower than 30-year rates. Conventional wisdom would be to opt for the shorter term. Here’s why you might consider doing otherwise:
- Rates are at all-time lows. All you have to do with the cash flow difference is make more than the rate on the loan, less the benefit of tax-deductibility, if any.
- You can turn a 30-year in to a 15. For that matter you can turn a 30-year mortgage into any term duration you want: just pay more.
- You may be better off sometime within the term of the loan having the extra cash flow. Consider the simple concept of CDs. From 1965 to 2000, the 90-day CD rate was never below 3.09% (it’s 0.12% as of October 2020)
Take the 30, Invest the Difference, Even in the Mortgage. The concept is simple: refinance for 30 years and set a new payment amount for either the number of years remaining on your existing loan, or some other term, like 15 years. The idea is to save the difference. If you aren’t sure what to do, simply pay more on the new mortgage. Or, invest in a Roth IRA if you can or make use of some other investment vehicle. There are three options:
- Refinance and pay your old payment
- Refinance and pay the term of the prior mortgage note
- Refinance and pay the minimum 30-year payment and invest the difference.
Suppose you took a $375,000 30-year loan out at 4.75% in April 2009. Your payment was $1,956. You currently owe about $286,966. You can get a 30-year fixed at 2.67%, with a payment of about $1,159. The new payment and rate look good, but remember you had about 18.3 years left on the old mortgage. Let’s look:
- Take the 30, pay the old payment of $1,956, have the loan paid off in 14.8 years. You save $82,159.
- Pay the 30 off over 18.3 years (220 months). You pay $1,654 a month and save $302 a month in a Roth IRA that make 6%. You save $66,524 in interest and will have a Roth with an additional $120,700 or so. Total benefit: $187,224.
- Pay the payment of $1,159 and stash the rest in a Roth IRA (You’ll need 2). You owe $84,879 or so, but you’d have a Roth worth $318,069.
The Pivot. The beauty of the 30-year is the flexibility. You can turn a 30-year into any duration loan less than 30 years. You can pay more on the loan or use the cash flow elsewhere. If CDs start paying 4% again, you can buy CDs and pay the minimum payment. Don’t forget how deductibility can make the rate even lower. We live in an unprecedented environment to take advantage of this situation.
Remember: you can always turn a 30-year mortgage into a 15, but you cannot turn a 15-year mortgage into a 30. When money is cheap, use Other People’s Money.
As always, I’ll try to answer questions. My email is firstname.lastname@example.org. Stay safe and look into refinancing.