30-year fixed mortgage rates rose above four percent in mid-2013, raising the question of whether consumers could ever expect to see sub-4 percent mortgages again. The simple answer is yes, and sooner than you think.
Even as 30-year fixed mortgage rates rose above 4 percent, 15-year fixed mortgage rates remained about a full point lower. In short, mortgage rates under 4 percent were still available - if you were willing to choose a shorter mortgage term.
Of course, the obvious drawback is that a shorter mortgage term means higher monthly payments. However, there are a number of advantages to a shorter mortgage term that can more than balance out that one drawback. These advantages can be brought into play whether you are choosing the length of your initial mortgage, or if you are thinking of refinancing to a shorter loan:
1. Lower your interest rate
According to mortgage finance company Freddie Mac, over the past five calendar years 30-year fixed mortgage rates have averaged 4.77 percent, compared to 4.18 percent for 15-year rates. So, over that period borrowers have been able save an average of 59 basis points by opting for a shorter-term loan. Better yet, this spread widened as rates started to rise in 2013, reaching a full percentage point by mid-November.
2. Pay interest for fewer years
Even if 15 and 30-year mortgage rates were the same, you would save a great deal on a shorter term mortgage simply by paying interest for fewer years. In fact, at the same interest rate, choosing a 15-year rather than a 30-year loan should cut your total interest expense by more than half, because not only are you cutting the time period in half, but you are also reducing the principal balance more quickly over the course of those 15 years. Run the interest totals for 15 and 30-year loans on a mortgage calculator, and see if you don't find the potential savings to be very attractive.
3. Build equity faster
Paying down principal sooner also means you build equity more quickly with a shorter loan. This can open up other home loan options for you, in case you want to refinance a mortgage or get a home equity loan.
4. Develop a tighter budget discipline
The higher payments that come with a shorter-term loan mean that more of your monthly budget is going to building equity, and less is available to spend on things that won't add to your net worth. Plus, when the mortgage is paid off, you will suddenly free a large chunk of your monthly budget for retirement saving, instead of continuing to make mortgage payments as you approach retirement.
5. Match up better when you refinance a mortgage
Typically, when you go to refinance a mortgage, you've already been making payments on it for a while, perhaps for a period of years. Why go back to square one with a 30-year mortgage, when you can refinance with a mortgage that matches up better with the time you have remaining on your original mortgage?
6. Own your home free and clear sooner
Think about it - a 35-year-old home buyer who takes out a 30-year mortgage won't own the home free and clear until it's about time to think about retirement accommodations. If you would like to enjoy years of living in a home you own with no strings attached, a shorter-term mortgage is the way to go.
If you think you would struggle to meet the higher monthly payments that come with a shorter-term mortgage, then by all means sign up for a longer loan. In that situation, it's not worth having the possibility of any financial setback driving you to the brink of default. However, if you are confident you can fit larger payments into your budget, the benefits of a shorter loan make a strong case for choosing this option.