Some decisions look easy. At first glance, refinancing your 30-year fixed rate mortgage to a 15-year mortgage seems like one of them. This refi sure does have its upsides. But there are also some things you’ll want to think about before you decide if it’s right for you. Let’s talk about them, shall we?
Your rate is lower and you pay less mortgage interest
The big win with this type of refinance is simple. You save on interest, which can keep a lot of money in your pocket. Interest rates are lower on 15-year loans compared to 30-year fixed rate mortgages. Often a good bit lower. The lower the interest rate, the less you spend. You also pay less total interest because you are borrowing the money for a shorter period of time.
So figuring you’ll live in your house a while, you’ll save in the long run – and that’s always a good thing. But, like many good things in life, a 15-year fixed refi comes with a trade-off.
You may end up paying a higher principal each month
Depending on what your current interest rate is on your 30-year loan, your monthly payments could be higher when you refi to 15 years. This is because you’re paying off your principal in half the time. If you end up making a higher monthly payment, this could leave you with less of a financial cushion for other monthly costs, such as unexpected repair bills, and future expenses (e.g., college tuition).
Keep in mind: A lot of mortgages come with no prepayment penalties. This means you can pay off the loan faster than the terms require and save on interest. Have extra money this month? Great, pay more if you want. Things a little tight? No problem, just pay the minimum.
An example of savings and payments
Say you owe the lender $200,000 on your mortgage loan, you have 20 years (240 months) left to pay it off, and your interest rate is 5%. If you refinanced into 15-year loan (180 months) at 4.5% interest, how would that compare in terms of overall interest payments to the 30-year loan?
We used our refinance interest savings calculator to create this chart and rounded the numbers to make them neater:
|Loan Balance||Fixed Interest Rate||Months Remaining||Monthly Payment||Total Interest Paid|
|$210 (more per month)||$41,381 (interest savings)|
You can see that you would save a whopping $41,381 in interest over the 15-year life of the loan by paying an additional $210 a month. Which ain’t a bad looking deal.
Don’t forget you need to pay closing costs
While you’re looking at that deal, remember you’ll have to pay closing costs to refinance. These typically run between 2% and 5% of the loan value. In our example, closing costs might be between $4,000 and $10,000, which still leaves you with pretty good savings.
As a rule of thumb, the longer you plan to live in your home, the more sense it makes to pay closing costs because you’ll enjoy bigger savings over a longer period of time. Figure out if paying these costs makes sense for you.
Think about other ways you might use the money
One more thing to consider. Think about that $210 as an investment and the $41,381 as a payoff. Could you make a better investment and get a better payoff someplace else? Other opportunities might result in a higher return, but they can also come with less certainty.
It might make more sense for you to put that extra $210 in savings into your kid’s college savings account or into your own retirement account. If you have other debts with a higher interest rate than your mortgage, you might want to pay those off first.
Check out our post on how to reduce your monthly housing costs for more savings tips!
Ditech is not a financial advisor and the ideas outlined above are for informational purposes only. They are not intended as investment or financial advice and should not be construed as such. Consult a financial advisor before making decisions regarding important personal financial matters, and consult a tax advisor regarding the deductibility of interest and tax implications.