Refinancing to a 15-Year Mortgage: What To Consider
If you had the option to make sacrifices in the short term for guaranteed benefits in the long term, would you do it? That’s the question facing borrowers pondering a refinance of their mortgage to a shorter-term home loan.
Most mortgages span 30 years, over which time homeowners typically pay tens of thousands of dollars in interest. Refinancing to a 15-year mortgage can yield major savings and help you to build equity faster.
“Let’s say that 18 months ago you borrowed $400,000 via a 30-year fixed-rate mortgage loan at 3.75% interest,” said Tony Davis, Chairman/CEO of Atlantic Home Mortgage in Alpharetta, Georgia. “Your monthly principal and interest payment, excluding taxes and insurance, would be $1,852. Assuming you made all your payments on time and didn’t pay anything extra, you would owe around $390,000 in principal and have approximately $245,000 in interest debt remaining over the life of the loan after making 18 months of payments.”
If you refinanced to a 15-year fixed rate of 1.99%, with your estimated closing costs of $6,000 financed into your loan, your new total monthly principal and interest payment would be $2,546, he said.
“In this scenario, so long as you can cover the extra $694 a month and continue making your payments on time, you will save approximately $183,000 in interest over the life of your new loan and pay it off more than 13 years sooner,” Davis said.
This strategy is helped by the fact that fixed interest rates for 15-year mortgages today are tantalizingly lower than for 30-year mortgage loans. The average U.S. rate for a 15-year home loan was 2.18% last week, according to Freddie Mac. That compares to 2.87% average rate for a 30-year mortgage.
Chances are that many mortgage borrowers considering a shorter-term refinance today probably took out a loan years ago with rates much higher than 2.93%, positioning them for considerable savings.
Problem is, a shorter loan life means higher monthly payments.
“A person who has stable income, has already taken advantage of any 401(k) matches by their employer, has already paid off high-interest credit card debt, is going to live in the house for the foreseeable future, and has discretionary income that can cover the higher amount is a good candidate for refinancing to a shorter-term mortgage loan,” said Khari Washington, broker/owner of Riverside, California-based 1st United Realty & Mortgage.
Someone with variable income – such as a self-employed borrower – or who has higher-interest debt that needs to be repaid first, or is planning to move in the next few years should probably steer clear of a refinance, he said.
Consider, too, that the extra dollars you’d be paying monthly after refinancing may be more effectively used elsewhere.
“In the current rate environment, many well-qualified clients can get a 30-year fixed rate below the cost of inflation," Davis said. "If inflation is at 3% and your 30-year mortgage rate is locked in at 2.99%, you are effectively borrowing money for free. Why would you want to aggressively pay down money you borrowed for free if you could invest that money to earn a better return?”
Historical stock market returns are roughly double prevailing mortgage refinance rates for well-qualified borrowers. Likewise, returns on many types of alternative investments, including real estate investments, are higher than existing mortgage rates.
Not everyone subscribes to that strategy, however.
“That’s not something I would generally advise unless someone is a savvy investor,” Washington said. “Most people don’t follow through on investing consistently, and you are trading a known debt for an unknown return. I recommend instead paying off higher-interest debt if you are not going to pursue a shorter mortgage term, because the return on your investment is clearly known.”
Alternatively, if you want to shorter your loan’s term and pay less total interest without the hassle and expense of refinancing, you can opt to make accelerated mortgage payments. With this strategy, you designate extra money applied toward your principal at intervals comfortable for you, such as making one extra mortgage payment a year – 13 payments instead of 12 – or paying $100 extra per month.