Rates Get Smaller and Loan Terms Get Shorter

Mortgage rates dipped to new record lows this week, giving homeowners a chance to pay off their mortgages earlier as they refinance with shorter-term loans.

The benchmark 30-year fixed-rate mortgage fell to 3.94% from 3.97% last week, according to the Bankrate.com national survey of large lenders. The mortgages in this week's survey had an average total of 0.46 discount and origination points. One year ago, the mortgage index was 4.69%; four weeks ago, it was 4.05%.

The benchmark 15-year fixed-rate mortgage fell to 3.15% from 3.19% the previous week, and the benchmark 5/1 adjustable-rate mortgage fell to 3.01% from 3.02%.

With rates so low, the opportunity to become mortgage-free in 15 years, rather than in 30 years, is tempting to many borrowers. But is it the right choice? It depends on whom you ask.

"If you are comfortable with the payments, I think it's worth it," says John Walsh, president of Total Mortgage Services in Milford, Conn.

Should You Go for a 15-Year Mortgage?

The shorter-term loan normally means slightly higher payments compared to what you currently pay on the 30-year mortgage, but it also means substantial savings over the years, Walsh says.

"Maybe they're paying 50 or 100 bucks more a month, but they are cutting 15 years off their mortgages," he says.

Take a borrower who currently pays about 6% in interest on a 30-year mortgage of $250,000. The borrower's monthly principal and interest total about $1,500.

Based on the rates on this week's survey, if the borrower refinanced that $250,000 into a 15-year loan, the borrower would pay $64,000 in interest over the life of the loan.

The same loan would cost the borrower more than $176,000 in interest if financed for 30 years.

The 15-year loan would carry a monthly payment of $1,745. That's about $245 more than what the borrower currently pays and $560 more than what the borrower would pay if the loan were refinanced into 30 years.

"A lot of people are looking to pay their houses off, more than a few years ago," says Michael Becker, mortgage banker for WCS Funding Group in Baltimore. "Every situation is different, but I recommend it to a lot of my clients."

Of the homeowners who refinanced in the first three months of this year, 31% replaced their mortgages with 20-year, 15-year or shorter-term loans, according to a recent Freddie Mac report.

Shorter-Term Loans Not Suitable for All

But not everyone agrees that shorter-term mortgages make financial sense -- at least not when analyzed from an investment standpoint.

"People ask me about 15-year mortgages, and I tell them it's the biggest financial mistake they can make," says Ed Conarchy, a mortgage planner and an investment adviser at Cherry Creek Mortgage in Gurnee, Ill.

With mortgage rates so low, borrowers should take advantage of borrowing "cheap money," he says.

By reducing their monthly mortgage payments through a longer-term mortgage, borrowers can use the money left each month to maximize their 401(k) contributions, he explains. They can also use the monthly savings to pay off debt with higher interest rates, such as credit card debt.

"You'd be amazed at how many people come to me wanting to get a 15-year mortgage when they have credit card debt and don't have a rainy-day fund," he says. "Max out your 401(k) contributions, pay off your bad debt and establish a six- to 12-month rainy-day fund, and then we can start talking about mortgage acceleration."

Depending on how your 401(k) investments perform, over the next 20 years, you'll likely make more than you would have saved with the shorter-term loan, he says.

But the real question is: "Will borrowers have the discipline to invest the savings in their 401(k)s or just spend the money every month?" asks Becker. "Every situation is different. It's really about what works for you."