Something interesting happened with mortgage rates in 2021. The average 15-year fixed mortgage rate was lower than the average 5/1 ARM rate. See the latest mortgage rate chart from Freddie Mac below. Notice the green line is lower than the red line and how much wider the spread is between them vs in the past.
Let’s discuss why the average 15-year mortgage rate was lower than the 5/1 ARM rate. This shouldn’t happen in a normal economic environment.
Based on data from Freddie Mac, the average 15-year fixed rate mortgage was only 2.27% versus the average 5/1 ARM rate of 2.64%. This is a massive difference that hopefully you were able to benefit from. But most people were simply unaware of this anomaly. If this type of scenario ever arises again, it should be exploited by savvy homeowners.
Before 2019, a 5/1 ARM was often much cheaper because the fixed duration was much shorter. The time value of money generally dictates that longer duration loans have higher rates (upward-sloping yield curve).
Only during times of great distress does the yield curve flatten or invert, which causes shorter term rates to be cheaper than longer term rates.
However, the yield curve became upward sloping as seen below.
Why Is The 15-Year Mortgage Rate Lower Than The 5/1 ARM Rate?
There are two reasons why the 15-year mortgage rate was lower than the 5/1 ARM rate in the example above. They were:
1) Lenders are more cautious during times of great uncertainty. Lenders tend to tighten their lending standards out of fear of losing money in the future. A 15-year fixed rate mortgage is considered less risky.
2) Borrower demand for 30-year amortizing loans (30-year FRM and 5/1 ARMs) is higher because borrowers want maximum flexibility and lower monthly payments during times of great uncertainty. This means that, conversely, borrower demand fo 15-year amortizing loans is lower.
Therefore, to entice mortgage borrowers to get a 15-year fixed rate mortgage, banks are willing to accept a lower spread. As the average 15-year mortgage rate drops, demand should increase. As demand increases, the average 15-year fixed rate mortgage rate eventually increases.
Is The 15-Year Mortgage The Best Choice?
Due to a 15-year mortgage amortizing over 15 years instead of 30 years, the monthly mortgage payment will usually be higher than a 30-year fixed rate mortgage or a 5/1 ARM.
However, if you can get a lower mortgage rate and pay down your mortgage quicker, it’s not a bad idea. I’ve never regretted paying down debt, regardless of how much more I could have returned investing the money elsewhere.
Less debt means more peace of mind and more freedom. When I paid off my 2/2 condo mortgage, I felt like a nice weight was lifted off my shoulders. Now, I get to earn higher cash flow each month that helps boost my passive income.
If you can afford the higher monthly payments, and the mortgage rate is at least 0.375% lower than an ARM or a 30-year fixed mortgage, I would definitely get a 15-year fixed rate mortgage.
One of the biggest mistakes homeowners make is paying too much for a mortgage that has too long of a duration. In other words, taking out a 30-year fixed rate mortgage is a suboptimal financial move.
Instead, you want to match the length of time you plan to have a mortgage and/or own the home. Given the average homeownership duration is between 8-9 years, usually, a 7/1 ARM or 10/1 ARM would be best. But if the 15-year fixed rate mortgage is much lower, then a 15-year fixed rate mortgage is probably the best way to go.
Just make sure that before you take out a 15-year fixed rate mortgage, you can comfortably afford the higher mortgage payments. If your all-in homeownership cost is less than 30% of your monthy gross income, you should be good to go.
The Lowest Mortgage Rate
The best way to get the lowest 15-year mortgage rate or any type of mortgage is to check online and get competing offers.
I recommend checking the latest mortgage rates online to see what you can get. Credible is my favorite online lending marketplace where qualified lenders compete for your business. Lenders will give you a free, no-obligation rate quote. From there, you can not only compare the lowest mortgage rate offers, but also compare the terms.