A 15-year loan can help you save big on interest
It can be smart to pursue a refi with a shorter term. Refinancing from a 30-year, fixed-rate mortgage into a 15-year fixed loan can result in paying down your loan sooner and saving lots of dollars otherwise spent on interest. You’ll own your home outright and be free of mortgage debt much sooner than normal. Plus, mortgages with shorter terms often charge lower interest rates. Consequently, more of your monthly payments will be applied to the loan’s principal balance.
But a 15-year mortgage isn’t for everyone. Be aware that your monthly payment will likely rise because you’re compressing the repayment schedule over a shorter period. As a result, you’ll have less cushion in your monthly budget, particularly if you’re on a fixed income. That extra money you’ll be spending could earn a greater rate of return invested elsewhere. You’ll also have less ability to deduct mortgage interest paid on your taxes.
Advantages of refinancing into a 15-year mortgage
Lenders often charge a lower interest rate for a 15-year mortgage than a 30-year mortgage. In addition to lowering your interest rate, you will create a more aggressive paydown schedule, which can save you thousands in interest in the long run. Also, you’ll build equity more quickly, which you’ll be able to tap via a future home equity loan, home equity line of credit or cash-out refinance if you need extra money.
You may actually be able to reduce your monthly payment, depending on the size of your current mortgage and how much lower the new rate is compared to your current mortgage rate.
Drawbacks of refinancing into a 15-year mortgage
Having all your money tied up in your home can be risky. Many financial experts recommend having at least three to six months of emergency savings set aside in case you lose your job or cannot work for extended periods.
Instead of refinancing a mortgage, you could contribute more money toward a 401(k) plan or an IRA account or beef up your emergency savings fund. The latter approach helps you avoid revolving credit card balances from month to month and incurring more debt at a higher interest rate.
What’s the difference in payments for a 15-year versus a 30-year mortgage?
The minimum monthly payment on a mortgage is the amount required to be paid in full each month. As the minimum payment for a 30-year mortgage will be lower than that of a 15-year mortgage, this allows more flexibility within your monthly budget. That can come in handy if your income changes, you lose a job or you have financial emergencies to cover.
Before converting to a 15-year mortgage, carefully consider the impact on your finances. Evaluate your ability to pay monthly expenses and how the higher payment will affect your capacity to pay down debts and invest, versus staying pat with the remaining term on your existing 30-year mortgage.
If your goal is merely to pay down your mortgage faster, you can accomplish this by simply making periodic extra payments on your existing mortgage loan. If you make enough extra payments over your loan term, you can easily shave time off your loan — even 15 years if you prepay aggressively.
The catch with this strategy is that you’ll probably pay a higher interest rate on your current 30-year mortgage compared with a new 15-year loan. You’ll also have the hassle of managing, specifying and sending in extra payments that will need to be applied to your loan principal.
Questions to ask before you refinance into a 15-year mortgage
- Can you afford the higher monthly payment?
- Is the money you ultimately save worth the higher payment every month, keeping in mind other goals you may have for the money?
- Will refinancing and paying more each month deplete your savings and emergency funds?
- Instead of making higher monthly payments, could you invest the extra money and earn a higher rate of return than the mortgage interest rate you’ll pay?
- Do you have other outstanding higher-interest debt (including credit card debt) that you should pay down first?
- Do you plan to remain in your home for several years after refinancing so that you can at least recoup what you paid in refinance closing costs?
- How many years remain on your current home loan? If it’s less than 18 years, is refinancing to a new 15-year loan worth it?
- How secure is your job? What would happen if you became unemployed or earned less in the future?
- Is it smarter and easier to simply make accelerated payments on your current mortgage?
- How much longer will you be eligible to deduct your mortgage interest paid if you refinance to a 15-year loan?