Fixed mortgages with shorter terms have lower rates -- compelling more homeowners to refinance their mortgage from 30 year mortgages to 15 year home loans. Paying less interest over the life of the loan is an attractive idea, but determining whether or not a 15-year home loan is appropriate is essential before refinancing.
Refinance to a 15 Year Mortgage: A Good Solution?
MSN Money recommends meeting all of these conditions before refinancing to a shorter-term:
- Save a minimum of three-to-six months for emergencies.
- Be sure higher mortgage payments won’t cause a shortfall in the monthly budget.
- Fund retirement accounts fully before taking on higher mortgage payments.
- Continue contributing to savings on a regular schedule.
Homeowners who have paid more than half of their current mortgage balance or who are planning to move in a few years may not realize sufficient savings as the costs of refinancing offset estimated savings. Double check this with a refinance breakeven calculator.
Best Candidates for 15 Year Refinance
A 15-year refinance is not for everyone. While you may want to pay off your mortgage quicker, it may not be a good fit for your finances. Following are some of the best candidates for a 15-year refinance:
- Those who aren't in the first year of their mortgages. A 15-year refinance is typically best for individuals who've been in their current mortgage for a few years. Refinancing too early will bring additional costs and extend your breakeven time (the point where your total, monthly savings exceeds your initial closing costs).
- Those who have been paying extra towards their mortgage. Refinancing to a 15-year mortgage will allow them to pay off their house quicker.
- People who are preparing for retirement. If you're near retirement and desire to be mortgage-free by the time you retire, a 15-year refinance might be a good decision.
- Those who have excess cash flow each month. If you have excess cash you don't need to use for other needs, refinancing to a 15-year mortgage might work for your benefit.
The above shows there are several instances where you might be a good candidate for a 15-year refinance. In short, 15-year mortgages allow those who have the means and can withstand the short-term pain of increased payments the advantage of becoming mortgage debt free sooner.
For those “good to go,” a 15-year mortgage is less likely to cause financial stress, but thinking ahead to the “what ifs” is also a good plan. Consider worst-case scenarios such as job loss or other hardships; the additional weight of a higher mortgage payment could make the difference between keeping the mortgage in good standing or struggling to make payments.
It's also important to remember that if your home has gone up in value, you may have a better chance of refinancing to a reduced loan term thanks to a lower loan-to-value ratio.
Why You Should Refinance with a 15 Year Mortgage
With interest rates at historic lows, you might wonder if you should refinance into a 15-year mortgage. Resetting into a 30-year mortgage can save money on your mortgage payments each month, but may hold you back from achieving other, longer-term goals. With that in mind, here are some of the reasons why you should refinance with a 15-year mortgage:
It saves you thousands in interest: The current difference in the 30 and 15- year mortgages is nearly .75 percent, according to Freddie Mac. An interest rate reduction of that magnitude might save you tens of thousands of dollars over the life of the loan.
It helps you pay off the mortgage quicker: This is another obvious benefit of choosing a 15-year refinance. You instantly cut your payment term by years, allowing you to pay it off sooner.
It can eliminate Private Mortgage Insurance (PMI):. If you put less than 20 percent down on your house, PMI will be added to your mortgage payment. If you have at least 20 percent equity in your house, going down to a 15-Year mortgage could save you $100 or more per month, depending on what you pay for PMI.
It allows access to home equity: You can do a cash out refinance to consolidate and pay off debt or for home improvements. If you do this, make sure not to rack up more debt and to focus on improvements that bring a greater return to the value of your house.
It can help you plan ahead for the future: This can apply to several situations, but if you are planning ahead for retirement and have excess cash, a 15-year refinance can help you go into retirement without any mortgage debt, allowing you to better plan for your retirement years.
In many ways, a 15-year refinance is a means of forced savings. It allows you to put excess cash into something that will hopefully appreciate more than simply saving money in a money market or savings account – not to mention helping you become free of mortgage debt much sooner.
Drawbacks of a 15 Year Refinance
A 15-year refinance sounds like a perfect option, but there are some drawbacks that need to be considered. It's true that you will save money and pay off your mortgage sooner, but some significant drawbacks include:
Your monthly payments will increase: Your payments will not double, but it is likely that they will increase by at least several hundred dollars per month. If your budget is unable to withstand such an increase you may find payments to be a challenge.
You may not be able to work towards other goals: The increase in payments will possibly pull you away from other goals, like saving for retirement, saving for your child's college fund, or paying off debt. You must look at your entire financial picture before refinancing to a 15-year mortgage.
Less flexibility with payments: Increasing your mortgage payments takes wiggle room out of your budget. While you may have no problem with your current payment, moving to a 15-year mortgage can take away any breathing room.
You may earn more by investing in the stock market: We all hope our homes will increase in value. However, it's arguable that you can earn a greater return in the stock market. If that is of significant concern to you, you may want to avoid a 15-year refinance.
There are a lot of reasons why a 15-year refinance can work out to your benefit, but it requires considerable due diligence. If you think a 15-year refinance might work for you, cash flow is vitally important. At the very least, you will want to keep a healthy emergency fund in place to deal with unexpected circumstances that arise.
Pay Now, Play Later and Save Big!
Prior to the recession, homeowners were confident about borrowing against their home equity; this easy source of cash funded everything from remodeling to world travel. In the aftermath of the foreclosure crisis, homeowners have realized the importance of building home equity by paying off their mortgages as quickly as possible.
While a 15 year mortgage requires higher monthly payments, it can also save thousands in interest paid over the life of the home loan. Here’s a comparison:
30 Year Mortgage
Mortgage amount: $200,000
Mortgage interest rate: 4.50%
Principal and interest payment: $1,013.37
Total interest paid: $164,813.67
15 Year Mortgage
Mortgage amount: $200,000
Mortgage interest rate: 3.625%
Principal and Interest payment: $1,442.07
Total interest paid $59,573.44
Most mortgages are refinanced or otherwise retired before their full repayment term, but this example illustrates the benefit of how interest is paid down much faster on a 15 year loan.
A 15 year mortgage offers more benefits; think of the improved cash flow a mortgage-free lifestyle can provide. A 1 -year mortgage can help you meet financial and personal goals ahead of schedule.
We all want to pay off our mortgage as soon as possible. A 15-year refinance can be a great tool to do just that; just make sure it's the best fit for your situation.