The mortgage industry is starting to make the move from short to long. Lenders are rolling out a new crop of 30-year fixed-rate mortgages...
The mortgage industry is starting to make the move from short to long.
Lenders are rolling out a new crop of 30-year fixed-rate mortgages that let homeowners make low, interest-only payments for as long as 10 or 15 years. It is the latest effort to snare borrowers seeking lower monthly payments.
Also getting a new push: mortgages that stretch for as long as 40 years.
The newest loans are aimed largely at borrowers who are looking for lower payments but are concerned about interest-rate risk. In recent months, mortgage experts have been surprised by the continued strong interest in adjustable-rate mortgages (ARMs) at a time when borrowers can still lock in a fixed-rate loan at rates well below 6 percent.
With rising short-term interest rates reducing the relative attractiveness of adjustable loans, lenders are seeing greater interest in loans that protect borrowers from rising rates — and are introducing mortgages for that market.
Last month, Wells Fargo & Co. rolled out a 30-year fixed-rate mortgage that is interest-only for the first 10 or 15 years. The interest rate remains the same throughout the life of the loan, but the monthly payment is recalculated after the interest-only period ends so the mortgage balance is paid off over the remaining 15 or 20 years.
U.S. Bank Home Mortgage, a unit of U.S. Bancorp, plans to introduce a 20-year fixed-rate mortgage with an interest-only feature for the first 10 years. Bank of America, IndyMac Bancorp and LendingTree.com, a unit of IAC/InterActive, all have fixed-rate interest-only mortgages in the works.
Locking in rates
The new breed of mortgages targets borrowers eager to keep monthly payments down but worried about rising rates. Among the choices:
30-year fixed-rate mortgages with interest-only payments for a set number of years cost less initially, but payments jump once borrowers begin paying on the principal.
40-year fixed-rate mortgages lower payments by spreading them over a longer term, but they cost more because borrowers pay more in interest.
20-20 mortgages are 40-year loans with a rate that adjusts once after the first 20 years.
Here’s what a borrower could pay for every $100,000 with three different mortgage products:
30-year fixed-rate: With an interest rate of 5.56 percent, borrowers would pay $572 a month for principal and interest.
30-year fixed-rate with interest-only period: With a 5.69 percent interest, borrowers would pay $474 a month during the interest-only period. Payments would increase when principal payments kicked in.
40-year fixed-rate: With an interest rate of 5.81 percent, borrowers would pay $537 a month for principal and interest.
Source: Credit Suisse First Boston
40-year loans find market
Forty-year mortgages — which keep monthly payments down but cost more over the long term — are attracting more notice after Fannie Mae’s recent decision to expand its purchases of these loans.
First offered in the 1980s, 40-year loans account for less than 1 percent of new mortgages, according to the Mortgage Bankers Association. More banks may be willing to offer them now that they know they can be sold to Fannie Mae, which has been buying 40-year mortgages since September 2003 under a pilot program with 22 credit unions. Fannie Mae will buy both fixed- and adjustable-rate 40-year mortgages.
Next month, IndyMac will reintroduce its 40-year mortgage, which was mothballed last year for lack of interest. Fannie Mae’s move “helps by bringing attention to the product and credibility to it,” IndyMac Executive Vice President Frank Sillman said.
“It also brings a host of investors that will purchase 40-year loans,” Sillman said.
Washtenaw Mortgage Co. in Ann Arbor, Mich., a unit of Washtenaw Group, began offering these loans last month. Old National Bancorp in Evansville, Ind., says it will add them over the summer.
Some lenders have been offering more and more interest-only mortgages in recent years to eager borrowers, although the vast majority of them have been adjustable-rate loans with interest-only features. These include both short-term adjustables, with rates that can adjust as often as once a month, and so-called hybrid ARMs that can carry a fixed rate for as long as 10 years, after which the rate can adjust annually.
ARMs and interest-only mortgages have been especially attractive to borrowers looking to keep their monthly payments down in the face of skyrocketing home prices. These loans accounted for nearly two-thirds of new mortgages in the second half of last year, according to the Mortgage Bankers Association.
Driving up home prices?
Among the increasingly popular choices: so-called option ARMs, which are short-term ARMs that carry introductory rates of as low as 1 percent and give borrowers multiple payment options. Because these loans allow borrowers to afford more house with a lower payment, some observers worry that they have helped fuel a heated housing market.
The growing popularity of interest-only and adjustable-rate mortgages also has raised fears that borrowers and lenders are taking on additional risks that could create problems down the road.
“The apparent froth in housing markets may have spilled over into mortgage markets,” Federal Reserve Chairman Alan Greenspan told Congress earlier this month. He called the “dramatic increase in the prevalence of interest-only loans, as well as the introduction of other relatively exotic forms of adjustable-rate mortgages … developments of particular concern.”
Lenders that now offer fixed-rate loans with interest-only features say they have seen a spurt of interest in these products in recent weeks as the yield curve has flattened, making ARMs relatively less attractive.
At Greenpoint Mortgage, a unit of North Fork Bancorporation, interest-only loans now account for about 30 percent of fixed-rate mortgages, up from 15 percent earlier this year. Countrywide Financial says activity in fixed-rate interest-only mortgages has been brisk recently.
Because they allow borrowers to lower their monthly payments, the newer mortgages are aimed at homeowners concerned about affordability and those who want cash available for other purposes. Unlike ARMs, which allow borrowers to get a lower rate in exchange for accepting the risk of future rate increases, fixed-rate interest-only mortgages carry the same interest rate over the life of the loan.
But like other interest-only loans, they tend to be more costly than standard mortgages. At Countrywide, the interest rate on an interest-only loan is typically one-eighth of a percentage point higher than the rate on a comparable loan without the interest-only feature. Wells Fargo says its borrowers typically pay about one-quarter point more in upfront costs — or $500 on a $200,000 mortgage.
Borrowers can face payment shock when the interest-only period ends. A borrower with a $200,000, 5.50 percent 30-year mortgage that’s interest-only for the first 15 years would see the monthly payment increase to $1,634 from $917 when the loan recasts so that the mortgage can be paid off in the remaining years, according to HSH Associates in Pompton Plains, N.J.
Some lenders and borrowers are looking to 40-year mortgages as an alternative to interest-only mortgages. The 40-year loans are likely to appeal to borrowers “in the middle of the country, who tend to be more conservative,” says James Cotton, vice president for single-family marketing at Freddie Mac, which is looking at buying 40-year mortgages.
Paying for an extra decade
Forty-year mortgages can be costly over the long haul. Rates on these loans tend to be about 0.25 to 0.375 percentage point higher than the rate on a comparable 30-year mortgage. Borrowers also pay more interest over time because the loan is stretched over an additional 10 years.
For a $200,000 mortgage with a 5.75 percent fixed rate, a borrower with a 40-year mortgage will pay roughly $312,000 in interest over the life of the loan, according to HSH Associates, versus about $220,000 in interest if the same loan has a 30-year term at the same interest rate. If the rate on the 40-year mortgage is 6 percent, the total interest payments jump to about $328,000.
Some lenders are tweaking the formula. Hingham Institution for Savings in Hingham, Mass., last year introduced a 20-20 mortgage, a 40-year loan with a single rate adjustment after the first 20 years. Because it is essentially two 20-year loans, the rate on the mortgage is one-quarter to one-eighth of a point below the rate on a standard 30-year loan.
“It’s been our most popular product,” Hingham Vice President Michael Sinclair said.