Homeowners looking to refinance a jumbo mortgage loan with a new, lower-rate loan, may want to consider a slightly unconventional alternative to traditional 15-year and 30-year fixed rate mortgages (FRMs).

Current rates on 20-year FRMs are at around 4.75%: low enough for many 30-year borrowers who took out loans at higher rates in 2005 or 2006 to significantly reduce their repayment periods without greatly increasing their monthly payments. The accelerated repayment period, in turn, can save the homeowner money that would otherwise be spent on interest, since the new rate will be lower than a 30-year rate and the time for repayment will be one third lower than the period for a 30-year loan.

20-year loans are becoming increasingly popular with homeowners who purchased their homes in boom times under jumbo mortgages (loans of over $700,000), especially those with loans exceeding $1 million. Homeowners can only deduct interest payments from their federal income taxes on loan amounts up to $1,100,000.

 

first tuesday take: When your buyer asks for quotes from mortgage lenders for a purchase-assist loan, inquire about the rates for 15-year, 20-year, 30-year and 40-year  amortizations with no due dates. Lenders will agree to make loans for any duration, but the loan term makes a difference in both the rate they quote and the amount they will lend: the shorter the amortization period, the lower the rate, and the lower the maximum loan amount available from the lender. At current rates, a homebuyer who makes his purchase with a 20-year loan will have monthly payments approximately 20% higher than under a 30-year loan, with a slight reduction in interest rates. [For more advice on when to pay down a mortgage, and when not to, see first tuesday’s March 2010 article, Paying down a mortgage: not always the best thing to do; for more advice on obtaining the best rates from competing lenders, see the first tuesday’s June 2010 Form of the Month.]

While 20-year mortgages have been around for a long time, and may be an excellent option for some wealthy (and cash heavy) homeowners in California, they remain out of reach and unadvisable for the majority of the state’s owners and buyers. 20-year mortgages simply do not fit the financial profile almost all home buyers need in order to borrow the maximum funds at the optimal rate, thus getting the most home they can possibly buy. 20-year loans typically require a minimum 20% down payment, and demonstrated income high enough to repay the loan (total payments should not exceed 31% of the homeowner’s income).

More appropriately, the most fiscally intelligent option is not to refinance if the homeowner’s mortgage exceeds the value of the property, as is the case for almost 2,500,000 California homeowners. The wisest of these homeowners will decide to abandon their non-recourse purchase-assist loans and try again with a different property, a different lender, and a different, less risky, homebuying environment. [For information on the mortgage loan default, and its impact on credit scores, see the June 2010 first tuesday article, The FICO score delusion. The advantages of mortgage default are also discussed at length in the April 2010 first tuesday article, The underwater homeowner: a balance sheet reality check Part 1 and Part 2.]

Re: “The 20-year mortgage alternative,” from the New York Times