Mortgages Part III – 15-year vs. 30-year Mortgages

Why are 15 year mortgages cheaper than 30 year mortgages?

The answer has to do with the interest-rate curve.  Contrary to what some may believe, the economy does not have one interest rate, but rather an infinite number of market-based rates, and dozens of important benchmark rates that determine the cost of money to different groups of borrowers.

interest rate curve

Mortgage interest rates respond to market-based interest rates, which may be seen as an upward-sloping curve on a graph, showing a Y-axis of % interest rates and an X-axis of different loan “terms” that represent the cost of money for time periods from 1 day, to 3 months to 30 years.

Generally, 15-year mortgage interest rates trade somewhat below 30-year rates, as lenders charge less to lend money for 15 years than 30 years.

For that matter, generally 3, 5, and 7 year mortgage rates are lower than 15-year or 30-year rates, which is where the ‘teaser’ rates for adjustable-rate mortgages (ARMs) come from, before those interest rates float upwards at the end of a their 3, 5, and 7-year fixed period. 

Mortgage borrowers historically refinanced after the fixed period, making it statistically reasonable – in pre-2008 crisis times – to charge lower rates for 3, 5, and 7-year interest rates.  The fact that ARMs got combined in a toxic manner with sub-prime lending temporarily gave ARMs a bad name, although I think they’re great products, and I got a 5-year ARM in 2001 and a later a 3-year ARM in 2006.

Please see related Mortgage posts:

Part I – I refinanced my mortgage and today I’m a Golden God

Part II – Should I pay my mortgage early?

Part IV – What are Mortgage Points?  Are they good, bad or indifferent?

Part V – Is mortgage debt ‘good debt’ A dangerous drug?  Or Both?

Part VI – What happens at the Wall Street level to my mortgage?

Part VII – Introduction to Mortgage Derivatives

Part VIII – The Cause of the 2008 Crisis

 

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4 Replies to “Mortgages Part III – 15-year vs. 30-year Mortgages”

  1. A little off topic, but the graph reminded me of something: yield curves compress before recessions.

    Try plotting the 10-yr Treasury rate minus the 3-month T-bill rate on FRED using the weekly data. The spread hits zero 1-2 years before a recession and hits about 3-4% when the economy exits recession. The pattern seems to work for the entire data series.

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I founded Bankers Anonymous because, as a recovering banker, I believe that the gap between the financial world as I know it and the public discourse about finance is more than just a problem for a family trying to balance their checkbook, or politicians trying to score points over next year’s budget – it is a weakness of our civil society. For reals. It’s also really fun for me.

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