In mortgage circles, 2013 will be remembered as a year in which 30-year fixed mortgage rates broke a streak which had seen them moving lower for seven years in a row. More subtly, another changing dynamic of the mortgage market was creating an unusual opportunity for consumers to save money on mortgage interest, and a recent change in Federal Reserve policy may enhance that opportunity even further.
The Mortgage Rate Gap
The money-saving opportunity for consumers stems from the fact that the gap between 30-year fixed mortgage rates and 15-year rates has gotten unusually wide. This means consumers who choose shorter home loans could save twice as much as usual on their mortgage rates.
According to data from Freddie Mac, at the end of 2012, 30-year fixed mortgage rates were at 3.35 and 15-year rates were at 2.65 percent, for a gap of 0.70 percent. A year later, 30-year rates had risen to 4.48 percent. 15-year rates had also risen, but less steeply, reaching a level of 3.52 percent by the end of 2013. As a result, the gap between 30-year fixed mortgage rates and 15-year rates had spread to 0.96 percent.
How unusual is that? Well, over the course of more than 20 years of mortgage rate history, that gap has averaged 0.48 percent, making the 0.96 percent gap at the end of 2013 exactly twice as large as normal. So, while consumers can generally save money on mortgage rates by choosing a shorter loan, that rate savings is now double what it usually is.
The Fed and the Spread
A change in policy announced after the last Federal Reserve meeting could make this gap even wider, or at least preserve the unusually wide level of the current gap. The Fed has been taking actions to lower both long-term and short-term interest rates. However, on December 18th the Fed announced that it was scaling back on its measures to reduce long-term rates. At the same time, the Fed also announced that it might prolong its measures to hold short-term rates down.
With the Fed giving long rates more room to rise while holding short rates firmly down, the gap between long and short rates in general could widen. The Fed does not directly control mortgage rates, but its recent policy change plays right into market forces that have already widened the gap between 30-year fixed mortgage rates and 15-year rates.
Smart Moves for Consumers
How can consumers take advantage of the unusually wide mortgage gap? Here are some moves to consider:
- Home buyers should consider shorter mortgages. Shorter mortgages entail making larger monthly payments, but the benefits include lower interest rates and fewer years of having to pay interest. That lower rate advantage has been enhanced by the unusually wide mortgage gap, meaning that now is an especially good time for home buyers to look into the possibility of choosing a 15-year rather than a 30-year mortgage.
- Refinancing short makes more sense than ever. When you refinance a mortgage, you generally face a choice between either lengthening or shortening your remaining mortgage term. For example, if you are ten years into a 30-year mortgage, you could reset the term back to 30 years if you refinance with a new 30-year mortgage, or you could shorten the term to 15 years by refinancing with a shorter loan. Unless your primary goal for refinancing is to lower your monthly payments, the unusually wide mortgage gap gives you an especially strong opportunity to save on interest by refinancing to a shorter mortgage.
- Be wary of ARM mortgage rates. The gap between 30-year fixed mortgage rates and 1-year adjustable rate mortgage (ARM) rates also widened in 2013, from 0.79 percent to 1.92 percent. By the same logic then, this rate gap might also seem to represent an enhanced opportunity to save money. Remember though, the context is that these gaps are widening as rates rise. An ARM is not where you want to be when rates are rising, unless you plan on paying off your mortgage within a few years.
The market may never again see the record low mortgage rates of late 2012 and early 2013. However, by paying attention to the changing dynamics between 15-year and 30-year mortgage rates, there is still a chance for savvy consumers to save money.