Should You Refinance to a 15-Year Mortgage?
Refinancing into a 15-year mortgage can save you money over the life of the loan, but it may not be the best option for everyone. A shorter mortgage term typically offers a quick path to equity, lower interest rates and thousands in savings, but there’s a lot to consider first. Upfront fees can eat up your savings, a higher payment can consume the wiggle room in your monthly budget and opportunity costs may make a 15-year mortgage refinance not worth it.
Pros of refinancing into a 15-year mortgage
A 15-year mortgage can save you money in several ways.
Less total interest paid
One of the biggest pros of refinancing to a 15-year mortgage is the lower interest rate. Interest rates for 15-year mortgages are often lower than a 30-year option, since the shorter term means the loan is less of a risk to the lender.
With a lower interest rate, not only are you paying a smaller overall percentage to the lender, but more of your payment each month goes toward the loan’s principal, exponentially reducing the amount of interest you pay in total.
Use a mortgage refinance calculator to estimate your payment and your savings.
Replacing an ARM with a fixed-rate mortgage
Adjustable-rate mortgages (ARM) is a mortgage with an interest rate that can change after a certain period of time. It can be a good choice when the market offers high interest rates and the rates may decrease. However, interest rates are now at record lows and experts agree that they’ll increase. It can make sense to lock in a low interest rate by switching from an ARM to a fixed-rate mortgage.
Private mortgage insurance (PMI) is typically required on conventional mortgages if you have a down payment of less than 20%. By law, lenders must automatically terminate PMI when your principal balance reaches 78% of the original value of your home at the time you took out the mortgage. If your home has appreciated since then, that appreciation can count as equity when you refinance.
For example, if you gave a 10% down payment on a $200,000 home that you’ve had for five years, and your house appreciated 8%, you should have more than 20% equity in your house now. If you refinance your house and do not take cash out, it’s likely you won’t be required to pay for PMI.
Even if you don’t yet have 20% equity in your house, a 15-year loan term will help you to reach that point more quickly and allow you to remove that extra cost sooner.
Switching from an FHA to a conventional loan
If you have a federal housing administration (FHA) loan, you must pay FHA mortgage insurance, which is also called mortgage insurance protection (MIP). For mortgages that were closed on before Dec. 31, 2000, have a case number assignment date before June 3, 2013 and have at least 22% equity, you may request that the MIP be removed. For all other FHA loans, you must pay the mortgage in full before the maturity date to remove MIP or refinance to a conventional mortgage.
MIP costs 1.75% of your loan amount annually, while PMI costs between 0.15% and 1.95%. If you can save money, it could make sense to switch to a conventional mortgage even if you would have to pay PMI.
A large amount of equity in your house means your loan to value ratio on your mortgage will likely be positive even if the housing market takes a dip. You’ll likely never owe more on your home than it’s worth, making it a secure investment if you ever have to sell.
At the same time, your money isn’t necessarily locked away. You could still access your equity if you needed it through products like:
Of course, you’re not required to borrow against your house. A 15-year mortgage means you’ll be debt-free in half the time of a 30-year mortgage. You’ll own your house outright in a quicker amount of time.
Cons of refinancing into a 15-year mortgage
Saving money in the long run comes with some up-front costs.
High likelihood of higher monthly payments
Condensing your 30-year mortgage into a loan term that’s half the length typically means that your monthly payment will increase. This may not be a problem if your income has increased or if your spending has decreased — you paid off a big loan, like auto or student loans. But if your financial situation hasn’t changed much, committing a higher percentage of your income to a set payment each month means you will have less financial flexibility.
Use a mortgage calculator to estimate your payments. You should still be able to contribute to your retirement account, your savings account and maybe a vacation savings fund. Don’t overstretch yourself financially — make sure you can comfortably make the payments because, as with any mortgage, if you default on the loan, you may lose the house.
Refinance closing costs
National average closing costs for a refinance were less than 1% of the loan amount — averaging $6,087 including taxes and $3,470 without taxes — according to 2020 data from ClosingCorp, a real estate data and technology firm. You can see a breakdown of mortgage refinance closing costs here.
That can be a lot to pay out of pocket, though some lenders give the option to roll some or all of these closing costs into your new mortgage. The biggest con of doing this is that you’ll pay interest on the amount borrowed. However, the biggest pro is that it could help you to maintain a rainy day fund for repairs, maintenance and life events. Experts recommend that consumers have three to six months of savings in case of income changes, job loss and emergencies.
While most mortgage interest rates are higher than the average bank account savings rate, there are still some opportunity costs of committing more money towards a mortgage.
Fun things. With more money going towards paying off a loan, you’ll have less to use for vacation, for a nicer car, for eating out. It could be better to have debt on your house rather than have high interest debt on a credit card or personal loan. Ensure that you won’t build up other obligations, especially other debt that has a higher interest rate.
Responsible things. Before you make a big move towards paying off your mortgage, make sure that it’s the smartest use of your money.
- Could you get a higher rate of return on investments?
- Have you maxed out your tax-advantaged savings accounts (e.g., a 401(k), individual retirement account (IRA), health savings account (HSA) or 529 college plan)?
- Have you paid off other debt that has a higher interest rate?
How to decide if a 15-year mortgage refinance is right for you
A 15-year mortgage refinance may be right for you if:
The new payment isn’t a problem. Taking on a higher payment can be a smart financial move if you’re not missing out on other opportunities and it won’t stretch your monthly budget too thin. It can help if your income has increased since you first took out the loan.
You’ll keep the house long enough to break even. With upfront closing costs being in the thousands, you’ll want to keep your home long enough that your savings on interest compensate for the fees.
The new interest rate is at least 0.5 percentage points less. A difference of 0.5 percentage points can create enough savings that you won’t have to keep your house forever to break even. Of course, the lower the rate you can get, the better. You’re more likely to be approved for a lower rate if your credit score has improved and/or national rates are lower.
Your current mortgage has at least 18 years left on it. It may not make the most sense to refinance a mortgage that has less than 18 years left on it for another 15-year term. If you have less than 18 years left on your mortgage, you could make extra payments to the principal rather than refinance.
Mortgage refinancing vs. making extra payments
If your goal is to save on interest, there’s more than one way to do it. Aside from a 15-year refinance, you could regularly make extra payments toward your principal balance. The pro of doing this is that you retain a low minimum monthly payment — so you have some flexibility in your budget if needed — and you still pay off your loan more quickly.
Say you have a 30-year, fixed-rate mortgage with a $200,000 loan amount and a 2.50% interest rate. If you pay an extra $550 each month, you could cut your total interest paid by more than half and effectively have a loan term bringing you closer to a 15-year payoff.
|Monthly payment (principal and interest)
|Total interest paid
|30-year loan for $200,000, paid off in 30 years
|30-year loan for $200,000, paid off in 15 years
|15-year loan for $200,000, paid off in 15 years
Questions to ask before you switch to a 15-year mortgage
Here are some questions to ask before you sign on the dotted line:
- Will you stay in the house long enough to meet the break even point?
- If there’s a higher payment, can you afford it?
- Do you have job security?
- Can you afford the closing costs out of pocket and maintain a healthy savings account?
- With a higher payment, can your rainy-day fund still cover three to six months of living costs?
- What are the opportunity costs?
- Could you invest the money and earn a higher rate of return?
- Do you have high-interest debt you could pay down?
- How much longer will you be eligible to deduct your mortgage interest if you refinance to a 15-year loan?