When you refinance, you may be tempted to move from a traditional 30-year mortgage to a 15-year mortgage that allows you to build equity faster and pay less interest.
Mortgage refinancing replaces your original loan with a new loan.
Before you take that step, figure out whether a larger monthly payment fits in your budget or whether you should simply pay more toward your current mortgage. Also, consider whether you’ll be approved for a new mortgage as banks started following stricter lending standards during the coronavirus pandemic.
Here’s what you need to know to help you decide whether to refinance to a 15-year mortgage.
[Read: Best Mortgage Refinance Lenders.]
What Is the Difference Between a 30-Year and a 15-Year Mortgage?
The main difference is that a 15-year mortgage is half the length, meaning you’ll pay less interest over the life of the loan compared with a 30-year mortgage. But you’ll also make bigger payments, as you’ll pay off your mortgage in 180 installments instead of 360.
Despite interest savings, mortgages paid off over 30 years are the most popular type by far, says Jerry Anderson, vice president of residential lending at Alliant Credit Union.
Some banks offer 15-year mortgage terms as well as lesser-known 10-year and 20-year mortgages.
Is Refinancing Worthwhile?
Refinancing is worth it if you can save enough money to cover the cost to obtain your new loan. Closing costs range from about 2% to 3% of the loan amount. That means you would pay between $4,000 and $6,000 on a $200,000 mortgage.
“The goal when people refinance is to lower the interest rate and lower the monthly payment” and then use the money toward other aims, such as savings, says Ron Haynie, senior vice president of mortgage finance policy, Independent Community Bankers of America.
Another way refinancing can be worthwhile is if you refinance to a loan with a lower term rate — like going from a 30-year loan to a 15-year loan. Your monthly payment might stay the same or even rise, but you’ll save a considerable amount of money in interest because you’re paying off your loan faster.
[Read: Best Home Improvement Loans. ]
Is Refinancing Into a 15-Year Mortgage a Good Idea?
Here are a few reasons that you might want to switch to a 15-year mortgage:
— To save on interest. The rate for a 15-year mortgage could be about half a percentage point less than a 30-year loan, saving you thousands throughout the life of the loan. How much you save will depend on how many years are left on your loan, taxes and other expenses.
— To pay off the loan faster. If you have at least 20 years left on your mortgage and can get a good interest rate, a 15-year loan will help you pay off your home faster. Look for a rate on a 15-year mortgage that is at least 1 percentage point lower than on your current 30-year loan, Haynie says. Your monthly payment might be the same, depending on how much you still owe on the mortgage.
— To prepare for higher expenses or lower income. Paying off your mortgage before retirement or major life events can help you reach your financial goals, but make sure you don’t commit to a payment that’s too high for you to handle.
— To build equity quicker. A 15-year mortgage allows you to pay off the loan quicker, which could pay off in the long run. “The decision between a 15-year and a 30-year is very specific to an individual’s situation, but if your goal is to create equity in your home more quickly, a 15-year is the better choice,” Anderson says.
Example of How a 15-Year Loan Can Benefit You
Here’s how refinancing to a 15-year loan could save you money, even with a higher monthly payment.
| 21 years left on original 30-year loan | 15-year refinance | |
| Current loan amount: | $200,000 | $200,000 |
| APR: | 4.5% | 3.25% |
| Total to be paid: | $309,515 | $252,961 |
| Total interest paid: | $109,515 | $52,961 |
| Monthly payments: | $1,228 | $1,405 |
That’s an interest savings of $56,554. After accounting for $4,000 in closing costs, you’ll still save more than $50,000 over the life of the loan.
When Is the Best Time to Refinance to a 15-Year Loan?
The amount of time and money left on your mortgage is a major consideration when you decide whether to refinance into a 15-year mortgage.
— If you have 25 years left on your 30-year mortgage: It might be too soon to jump into a 15-year loan unless you’ve paid down a chunk of your debt and can get a much lower interest rate. The higher the loan principal, the more likely your monthly payments will rise significantly.
— If you have 15 years left on your 30-year mortgage: The timing might be ideal for refinancing to a 15-year loan. That’s because you have basically the same amount of time left on the loan and can take advantage of a lower principal balance, Haynie says.
— If you have 10 years left on a 30-year mortgage: Haynie says, “I wouldn’t refinance it.” You could just add a couple of hundred dollars to your monthly payment on your current loan to pay the principal down faster and be better off than you would refinancing and owing thousands of dollars in fees.
[Read: Best Mortgage Lenders.]
What Are Alternatives to 15-Year Mortgages?
You can still reach your goal of paying off your home loan early without turning to a 15-year mortgage. Here are a few ways how:
— Take out a 20-year mortgage. You don’t hear a lot about this option, but it can offer an eighth or a quarter of a percentage point drop in interest from a 30-year mortgage, Haynie says. The 20-year mortgage is much less attractive to consumers because interest rates more clearly mirror the 30-year rate product than a 15-year loan, Anderson says.
— Pay extra on your 30-year mortgage. If you keep your 30-year mortgage but want to pay it down faster, you could put a little more toward the principal each month to reduce the number of payments you’ll have to make. Another option is to set up automated biweekly payments, which result in an extra payment each year and could help you save on interest and knock a few years from your mortgage.
If you’re still uncertain whether to refinance, Anderson suggests asking yourself whether you can comfortably afford the higher 15-year loan payment.
“If that is an issue, simply making one to two extra payments per year on a 30-year mortgage can help you pay your loan off more quickly while still keeping your lower 30-year mortgage payment,” he says.
The Pros and Cons of Refinancing to a 15-Year Mortgage
There are some clear trade-offs when switching to a 15-year mortgage, but they are straightforward to evaluate.
Pros
— Save money. As illustrated in the example, simply by getting a lower interest rate and paying off the loan six years faster, you could save more than $50,000.
— Quicker payoff. It might be easier to reach your long-term financial goals if you can refinance to a 15-year mortgage well before retirement.
Cons
— Added costs. Any time you refinance, you’ll end up paying fees — possibly 2% to 3% of your loan amount.
— Higher payments. If you refinance from a 30-year to a 15-year mortgage, your monthly payments will likely rise at least a little, unless your APR drops considerably. In the example, even with an APR decrease of 1.25 percentage points, the monthly payment still rose by $177 a month.
If you can afford the higher monthly payment, a 15-year refinance can pay big dividends. Haynie says to ask yourself: “Does that make sense, given what your life plan is (and) what’s in front of you?”
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Should I Refinance to a 15-Year Mortgage? originally appeared on usnews.com
Update 01/04/22: This story was published at an earlier date and has been updated with new information.
