The appeal of a short-term loan

Could I refinance you into a seven-year fixed-rate mortgage at 2.99 percent? Or how about 10 or 15 years fixed in the mid-3s?

These may sound suspiciously like teaser quotes with tricks in the fine print, but they are in fact signs of an important shift under way among American homeowners: Not only have they been refinancing at a robust pace in recent weeks, but they’re ratcheting down on the remaining number of years they plan to pay on their mortgages.

Freddie Mac chief economist Frank Nothaft calls the shift to shorter terms “a very strong trend.” In his company’s latest quarterly survey of refinancers, more than one out of three borrowers who ditched their 30-year fixed-rate loans opted to replace them with 15- or 20-year mortgages at near-record low rates.

Among community banks and lending institutions who originate mortgages to retain for their own portfolios, the trend is toward even shorter maturities. Jeff Lipes, president of the Connecticut Mortgage Bankers Association and senior vice president of Family Choice Mortgage near Hartford, Conn., said some institutions are now dangling fixed rates just under 3 percent to refinancers who want to compress their terms to as little as seven years and are willing to set up automatic payment withdrawal accounts.

“It can make a lot of sense if you can do it,” he said — especially for baby boomers in their 50s who want to be mortgage-free by the time they hit retirement.

Lipes provided this example to illustrate how it works. Say you’ve got a mortgage balance of $150,000 on a 15-year fixed-rate loan at 5.5 percent that you refinanced and it has 13 years to go. Monthly principal and interest come to $1,225. Over the next 13 years — 156 months — you can expect to pay $191,100 to your lender before retiring the note.

But if you refinance that $150,000 into a seven-year fixed-rate mortgage at 3 percent, you’ll have 84 payments remaining at $1,982 a month, totaling $166,488 over the full term. Factor in $3,000 for closing costs to obtain the refi, and your overall payout to the bank will come to $169,488 — a $21,612 saving and a debt-free house in half the time.

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Obviously you need to have the income or financial reserves sufficient to pay the extra $757 a month, which may be a bar too high for many pre-retirees. Plus you need to be able to qualify for a refi in the first place under today’s toughened underwriting standards.

Paul Skeens, chief executive of Colonial Mortgage in Waldorf, Md., said shifting to shorter-term debt “is a great move” — he’s refinancing his own home to a 10-year term right now — “but do you have the appraisal to support it? Do you have the credit scores you need?”

With short sales and bank foreclosures still a heavy drag on market values, getting an appraisal high enough for a refi “can be almost impossible in some areas,” he said. For some low-cost refi programs, lenders want to see at least 25 percent equity in the house. Higher FICO credit score requirements by Fannie Mae and Freddie Mac are another big impediment; both companies reserve their best rates for borrowers with 740 FICOs and higher.

The shift to shorter-term loans is part of an even broader trend among consumers emerging from the scary moments of the recession and global financial crisis: de-leveraging, reducing long-term household debt burdens, and getting out of adjustable-rate loans. According to Freddie Mac data, “cash-out” refinancings, where homeowners increase their mortgage debt by more than 5 percent, accounted for just 25 percent of refinancings in the latest quarter, compared with 80 percent and higher during the boom years.

In the first quarter of 2011, 84 percent of homeowners who refinanced hybrid adjustable-rate mortgages switched to fixed-rate replacement loans ranging from 15-year to 30-year terms, says Nothaft. Part of the reason, he believes, is that today’s rock-bottom fixed rates — with conventional 15-year rates in the upper 3 percent range and 30-year loans averaging just above 4.6 percent — are exceptionally attractive.

Plus, Nothaft said, “there’s a lot of chatter about the [Federal Reserve] pushing rates up” in the coming months, so many homeowners are checking out their options on locking in rates that may well be the best they’ll ever see again. Freddie Mac’s own forecasts put 30-year fixed rates at 5.25 percent by the final quarter of this year.

The takeaway here: Even if you’ve already got a low mortgage rate, consider going shorter term, lowering your rate even further, and owning your home debt-free sooner.
Ken Harney is a syndicated real estate columnist.

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