Sep
2
Why are mortgage loan interest rates higher for fixed rate mortgages held for longer periods of time?
Filed Under Renting & Real Estate
Esq asked:
I am sorry if this sounds like a dumb question, but I don’t understand. For example, why are 30 year fixed mortgage rates the highest mortgage rates, vs say a 15, and why are 15 year fixed rate mortgages higher than adjustable rate mortgages ? It seems that lending institutions are taking greater risk with a ARM vs. a Fixed rate mortage and they should pay a higher rate (For example, compared this situation to a new car loan vs a used car loan–the risk is higher on a used car loan ?? ??
I can understand a fixed rate loan of 30 higher than a 15 –greater risk of default from the borrower, BUT I still don’t get the ARM being so low.
Antonio
I am sorry if this sounds like a dumb question, but I don’t understand. For example, why are 30 year fixed mortgage rates the highest mortgage rates, vs say a 15, and why are 15 year fixed rate mortgages higher than adjustable rate mortgages ? It seems that lending institutions are taking greater risk with a ARM vs. a Fixed rate mortage and they should pay a higher rate (For example, compared this situation to a new car loan vs a used car loan–the risk is higher on a used car loan ?? ??
I can understand a fixed rate loan of 30 higher than a 15 –greater risk of default from the borrower, BUT I still don’t get the ARM being so low.
Antonio
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3 Responses to “Why are mortgage loan interest rates higher for fixed rate mortgages held for longer periods of time?”
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Erica
30 years takes longer to get your investment back (less on the front and more on the back of the loan). Adjustable rate the lender is hoping for the rate to be higher when it adjusts or it is set for a given time to adjust up no matter what the rate is. On a 15 year the default is lower due to being 1/2 the time.
Gabriel
The reason a 30 may be more interest than a 15 yr is because there is more risk that interest rates could increase during that time and the bank could be losing money at that rate vs. making a subsequent loan at higher interest. The reason that variable rates are lower is because they could follow any increasing interest rates up. I forget what the variable rate was on the free HELOC my lender gave me during a refi in 2005, but that interest rate had gone as high as 7.5% between then and the 3.75% it is now. But I also remember a time when normal mortgage interest rates were double digits, high enough that a bank offered me a discount if I paid off a 10% land contract early.
Andre
The lender is taking basis risk on longer term loans since no one knows where rates will be in 15 or 30 years. The bank looks at the yield curve and prices the loan based off of a spread for 15 and 30 year product. ARMs are cheapest because they recast earlier and there isn’t as much interest rate risk in the short term.