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What's The Better Mortgage: 30-Year, Or 15 At Lower Rate?

Mortgage banker Tom Jacobs gets many questions from homeowners.

Lately, they've been asking what he thinks of 15-year mortgages rather than the typical 30-year variety.

"I totally get" that they want to pay off their loans sooner, says Jacobs, at VanDyk Mortgage in Grand Rapids, Mich.

But he asks: "What if you could have a much lower payment and still have the opportunity to pay it off early if you have the extra cash?

A 30-year "gives you more flexibility" to pay down your principal without a penalty vs. the 15-year, Jacobs says. His advice: Go for the longer loan, as with rates near all-time lows, the benefit of the shorter mortgage — it can cost half a percentage point less — "is not that significant.

Despite growing availability of shorter terms, most borrowers still opt for 30-year fixed-rate mortgages, to keep monthly costs down.

The 30-year fixed-rate mortgage accounted for 60% of refinancing applications and 86% of those for homebuying in September, says the Mortgage Bankers Association.

"With record-low interest rates, 30-year mortgages are the king of the market," said Keith Gumbinger, vice president of loan information provider HSH.com. "They appeal to the widest possible audience.

Average interest on a 30-year fixed-rate loan is 3.65% and a 15-year is 2.95%, according to the MBA's latest data. A 20-year can be somewhere in between.

Borrowers who like the low payments of a 30-year mortgage, but then decide to pay it down early, need to make specially earmarked principal payments separate from their regular monthly installment.

Shorter Loans Get Affordable Mortgage watchers say that with their lower interest rates, loans shorter than 30 years are becoming more appealing to some borrowers.

"Fifteen-year, 20-year and even 10-year fixed-rate products have seen an uptick relative to previous refinancing booms," said Greg McBride, a Bankrate.com analyst.

Nearly 22% of borrowers looking to refinance chose 15-year terms in September, according to the MBA. It doesn't have figures for 20-year loans, but "fixed other" made up 14.6% of total refi applications, the bulk thought to be 20-year terms.

The shorter-term products are better suited to refinancers than to home purchasers, industry watchers say. And then only for those who've built equity and can handle a monthly payment that high.

For serial refinancers trying to improve their equity position, 20-year terms are among the most popular, Gumbinger says. Monthly payments for these are higher than on 30-year mortgages but lower than on 15-year loans.

One reason for their appeal is that refinancers could shave years off their current mortgage without needing to boost payments.

Say a borrower began with a 30-year mortgage in 2006 and refinanced to another 30-year mortgage at a lower interest rate in 2010, Gumbinger says. Now that borrower could take a 20-year fixed-rate mortgage at a significantly lower interest rate and make the same monthly payments.

Fifteen-year loans present "a rare opportunity" for borrowers now in a 5%-to-6% mortgage to drive down long-term interest costs, a recent Bankrate.com report said.

The report noted that even some underwater homeowners — owing more than their homes are worth — are tempted to cut years off their terms. It said nearly 18% of borrowers refinancing via the Home Affordable Refinance Program in August chose 15- and 20-year mortgages.

HARP 2.0, as it's called, doesn't require a borrower to be underwater. It can reduce some fees and streamlines the refinancing process.

When buying a home, shorter-term mortgages don't work for most borrowers — especially for those trying to "stretch into" their first homes, Gumbinger says.

Even in a refi, McBride says, it might not be wise for those on tight budgets "to pull every spare nickel" into paying down a mortgage faster.

"I can think of a lot of other financial priorities than accelerating payments on a mortgage debt with an after-tax cost of 3%," he said. They include paying down credit-card debt and funding tax-advantaged savings or retirement accounts.

Adjustable-rate mortgages are making a minor wave as well, especially five-year fixed loans that then adjust yearly, known as a 5/1 hybrid.

The five-year fixed rate is now around 2.7%, almost a full percentage point below a 30-year fixed rate, offering "compelling value for someone who doesn't plan to be in their home forever," McBride said.

With memories of the mortgage meltdown still fresh in borrowers' minds, though, he says they're largely shying away from adjustables.

A Return To ARMs? Hybrid ARMs made up 4.77% of the MBA's September purchase applications and 3.88% of refinancing. "People are playing it safe, predominantly favoring the 30-year fixed," McBride said.

But adjustable-rate mortgages might be a good bet for certain investors looking to maximize cash flow, according to Gumbinger.

Take a $350,000 mortgage, he says. At today's rates, a five-year ARM would save about $15,000 over that span vs. a 30-year fixed. And principal would be paid off faster, about $9,000 over the five years.

"That can be the difference between a profitable investment and one that is not profitable," Gumbinger said. And rental income could also be coming in over that time.

Jumbo-mortgage borrowers might also benefit from a 5/1 ARM. On a $1 million mortgage at today's rates, the savings is almost $60,000 over five years, Gumbinger says.

ARMs virtually disappeared after housing crashed in 2006, but lenders have been offering more of them since 2010 as their books improved.

What of that once-popular moneymaking tool, the second mortgage

"The rates are plenty attractive," McBride said. "The problem is people just don't have the equity they once had. The other thing is that consumers are focused on getting out of debt, not adding to it."