When purchasing a home, one of the most confusing aspects of the process is selecting a loan. There are many different financial products to choose from, each of which has advantages and disadvantages. The most popular mortgage product is the 30-year fixed rate mortgage (FRM).
This article discusses how the 30-year compares to other mortgage products, benefits of the 30-year, and fess to avoid when selecting a 30-year mortgage.
In 2016, 90% of borrowers used a 30-year FRM to purchase their home. The reason this loan is so popular is the certainty it offers coupled with the low rates.
Where is the Market Headed?
Expert economists predicted the economy would rebound in 2010. However, the economy was sluggish with slow growth rates for many years beyond that. The economy contracted in the first quarter of 2014, but in the second half of 2014 economic growth picked up. The Federal Reserve tapered their quantitative easing asset purchase program & the price of oil fell sharply. Consumer perception of inflation and inflation expectations are set largely by the price they pay at the pump when they refill their gas. With growth picking up the consensus view is interest rates will continue to head higher for the next couple years into 2020, or until a recession happens. The following table highlights 2019 rate predictions from influential organizations in the real estate & mortgage markets.
2019 30-year Fixed Mortgage Rate Predictions
|Mortgage Banker’s Association||Mike Fratantoni||5.1%|
|Fannie Mae||Doug Duncan||4.8%|
|Freddie Mac||Sam Khater||5.1%|
|Moody’s Analytics||Mark Zandi||5.0%|
|Wells Fargo||Sam Bullard||4.9%|
|Carrington Mortgage||Rick Sharga||5.25%|
|National Association of Home Builders||4.81%|
Table sources: MBA, Fannie Mae, Freddie Mac, NAR, NAHB, CoreLogic
The NAHB sees 30-year fixed rates rising to 5.08% in 2020, when they anticipate ARMs to jump from 2019 estimates of 4.46% to 4.63%.
Comparison to Other Mortgage Rates
When selecting a mortgage, there are many different mortgage products and terms to choose from, each of which has different interest rates. While 30-year fixed rates are near an all-time low, and were recently below 4%, they are still higher than other loan options with a shorter duration. 30-year rates can be compared to the following popular products:
- 15-year Fixed Rates – 15-year fixed rates are normally lower than a 30-year and, depending on the lender, the interest rate variance ranges from 0.50% to 0.75%. These rates are often lower because having a shorter term provides significantly less risk to the lender. Although interest rates are lower, 15-year payments are higher than 30-year payments because the loan has to be paid off in half the time.
- Adjustable Rate Mortgage (ARM) – An ARM often comes with interest rates well below those of a 30-year. With an ARM, a borrower receives a very low fixed interest rate for an introductory period of time, which normally ranges form 1 to 7 years, before the rate adjusts to a higher level. Normally, the shorter the initial low interest period is, the lower the interest rate is. The most common ARM product is the 5-year Adjustable Rate Mortgage, which commonly comes with an interest rate 1% less than a 30-year. After the introductory period is up the loan’s rate regularly adjusts every 6-months to year based upon a reference rate like the London Interbank Offered Rate (LIBOR) or the 11th district Cost of Funds Index (COFI). ARMs come with an interest rate cap, though this cap is typically significantly above the rates charged on FRMs.
- Interest Only Mortgages – While they are not as frequently offered today as in years past, many borrowers still opt for interest only mortgages. Since interest only loans do not require principal payment and do not amortize, the balance due never decreases. Because of this, lenders assume a lot more risk and often require a sizable down payment and charge higher interest rates. Interest only mortgage rates are commonly 1% higher than 30-year rates.
The Best Time to Get a 30-year Mortgage
The best time to get a 30-year mortgage is when interest rates are low. Interest rates tend to fluctuate significantly over time. Recently average 30-year rates were below 4%, but prior to the recession were above 6% and were as high as 18.45% in October of 1981.
Rates depend on various economic factors, including the following:
- Supply and Demand – Like all other items in our economy, supply and demand have a significant impact on rates. If many people are looking to purchase a home or refinance, rates tend to go up because of the increased demand. If interest rates are high and fewer people want to refinance or buy a home, demand is low and the rates will fall.
- Demand for Credit – Pension funds and other institutional investors have a strong demand for low-risk credit. Banks package individual mortages into mortgage-backed securities (MBS) which are sold off to investors.
- Core Rates – Sovereign credit from the United States government is viewed as having no default risk, as the Federal Reserve can print more money to pay outstanding debts. Investors demand a premium over governmental bonds to compensate for mortgage pre-payments & the risk of default.
- Inflation & Inflation Expectations – Inflation also has a large impact on rates. As an economy heats up, inflation will naturally set it. To slow inflation, the Federal Reserve will be required to raise interest rates to tigheten credit conditions. If an economy is worsening and inflation subsides, the Federal Reserve will then reduce interest rates. While raising or lowering the Federal Funds Rate does not have a direct impact on mortgage rates, mortgage rates tend to follow the federal rates over time, and typically are a bit higher than the rate on the 10 year treasury notes. While most mortgages have a 30-year term, most people tend to move or refinance roughly every 5 to 7 years, which is why the loans are indexed against the yield on 10-year treasury notes.
A Popular Choice Among Homeowners
The 30-year FRM is easily the most popular choice among both home buyers and people choosing to refinance their home loans into a lower rate.
If one looks at the market as a whole, people using 15-year FRM to refinance makes the overall market composition look a bit more even than it would without refis.
If one looks exclusively at purchases FRMs are about 90% of the market.
Benefits of Selecting a 30-year Mortgage
Selecting a 30-year over other options comes with many benefits. Some of the benefits are:
- Fixed Payment – The first benefit of selecting a 30-year fixed mortgage is that it comes with a fixed payment. Many borrowers in the past few years have been enticed to select an ARM which offers a very low initial interest rate. Once these ARMs adjust, many homeowners have found themselves in trouble because they didn’t realize how high their payment would be, and the new adjusted payment was unaffordable. With a 30-year, you know exactly what your required payment will be over the course of the loan.
- Build Equity – Another advantage of selecting a 30-year is it allows a homeowner to build equity. Each month, a portion of the payment goes towards paying down the loan, which in turn builds a homeowner’s household equity. Other products, such as interest only loans, do not allow a homeowner to build equity.
- Increased Cash Flow – Another benefit of selecting a 30-year is that it increases your cash flow. While a 15-year comes with a lower interest rate, the monthly payments can be significantly higher than a 30-year. By selecting a 30-year, a borrower could save hundreds of dollar each month which could be invested in higher yielding investments, or spent elsewhere.
Costs to be Aware of
While there are many benefits of selecting a 30-year, some lenders attempt to lump additional costs of fees into the mortgage. Paying closing costs is ultimately unavoidable, as you have to cover the bank’s costs & those who tell you there are “no closing costs” typically roll these costs into the loan via a higher interest rate. Some of the most common costs or fees that borrowers should be aware of are as follows:
- Property Mortgage Insurance – PMI is an insurance policy which protects the lender in case of default. Home buyers who put less than 20% down on their home are typically required to pay PMI until the loan to value (LTV) falls below 80%.
- Points – The most common fee that often comes with 30-year are mortgage points. A point is a fee which is either lumped into the loan balance or paid by the borrower at closing. A lender often uses points to pay down the 30-year interest rate to a lower level, which entices a borrower. Generally speaking, each point, which costs 1% of the loan balance, and pays down the interest rate by 0.125%. to 0.25%. Depending on the loan, a mortgage borrower may recoup the point fees after 3 to 5 years, though in some cases it can take significantly longer. If the homeowner sells the home before reaching the break even point then they lost money buying points.
- Pre-Payment Penalty – Some lenders charge a pre-payment penalty to their borrowers. This penalty will charge a borrower a fee equal to a fixed percentage of the loan balance if they attempt to payoff the loan early. This fee normally phases out after 3 years, but can be as high as 2% of the balance. These fees are more commonly included in bad credit mortgages. Some home owners pay off 99% of their home & then wait out the expiration of the pre-payment penalty before paying off their small remaining balance.
Homeowners May Want to Refinance While Rates Are Low
US 10-year Treasury rates have recently fallen to all-time record lows due to the spread of coronavirus driving a risk off sentiment, with other financial rates falling in tandem. Homeowners who buy or refinance at today’s low rates may benefit from recent rate volatility.
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