When it comes to financing a home, the majority of Americans still opt for the trusty, tried-and-true 30-year fixed-rate mortgage. But according to a new report from government mortgage giant Freddie Mac, shorter-term loans are catching up to their long-haul brethren.
About 43 percent of Americans opted for a 15- or 20-year loan when refinancing in the fourth quarter of 2011, Freddie Mac reported, the highest share since the first quarter of 2003.
Why? Still spooked by memories of the recession and an unsteady jobs picture, consumers remain focused on paying down debt faster, says Greg McBride, senior financial analyst at Bankrate.com.
Although shorter-term loans generally have higher monthly payments, they also tend to have lower interest rates. Compared to a 30-year fixed-rate mortgage, average rates on 15-year fixed loans were about 0.7 percentage points lower during the fourth quarter of last year.
"The savings come in the form of building equity faster and eliminating the loan years earlier," McBride says.
There's also been a marked shift from adjustable-rate mortgages, en vogue a few years ago during the housing boom, to fixed-rate mortgages. McBride isn't surprised by the shift given the havoc those types of loans wreaked on households and financial markets.
"As for the preference for fixed-rate mortgages, that's a residual effect of what happened to adjustable-rate mortgages that precipitated the mortgage crisis," McBride says. "It kind of scared them into the traditional fixed-rate mortgage."
With interest rates near historic lows—average rates for 30-year fixed-rate mortgages continue to hover near or below 4 percent—borrowers can afford to go with the extremely safe fixed-rate option.
"A homeowner in the marginal 25 percent tax bracket is essentially borrowing the money for free when you factor in taxes and inflation," McBride says.
Still, that doesn't mean adjustable-rate mortgages have no place in the home finance world. Certain borrowers can save a ton of money with some types of ARMs, especially if they plan to stay in their home for a shorter period of time.
"Adjustable rate mortgages offer tremendous value for some borrowers, that's always been the case," McBride says. "The problem was during the housing boom, what was designed as a product to benefit a niche borrower instead came in contact with mainstream borrowers."
For example, if a homeowner only plans to stay in her house for another few years, a 7/1 adjustable rate mortgage might be a good option. A 7/1 ARM has a fixed rate for 7 years, then turns into an adjustable rate mortgage for the remaining 23 years of the loan terms.
So if the homeowner plans to stay in her home for fewer than 7 years, she gets the benefits of a fixed-rate mortgage—no surprise rate jumps—at a potentially lower cost.
"There's great value in there and you could realize significant savings because you might be borrowing at 3.25 percent versus 4 percent," McBride says.