The pros and cons of refinancing to a 15-year mortgage
Consequences of a 15-year refinance
- Loan is paid off quicker, but monthly payments are higher
- Ties up flexible cash
- Interest rates are lower, but tax deductions are affected
Refinancing a mortgage is often a fairly easy decision: You want to lock in a lower interest rate and maybe pull some equity out of your house. Perhaps that looming adjustable interest rate kicks in soon and has you spooked, and you’ll feel better if you can get into a fixed-rate mortgage.
While you’re refinancing, should you use your extra cash to pay off your home sooner? What are the pros and cons to refinancing from a 30-year mortgage to a 15-year term?
As with any decision, do your research. It’s wise to check with a financial advisor and possibly a tax advisor before you move to 15 years. Search for an online amortization calculator, but understand that any figures you come up with are ballpark numbers. Most calculators don’t factor in closing costs, fees, property taxes, insurance, etc. Your lender will help you hone in on better numbers and work with you to make an informed decision.
Pros: 15-year vs. 30-year
Pay off mortgage in half the time
For those who yearn to be debt free, this is a relatively quick way to get out from under one of the biggest monthly expenses most of us have. This may be a concern if you closer to retirement years, or know you’ll lose a steady income stream before the 30 years is up.
The interest rates on a 15-year mortgage are most always lower than a 30-year loan. This can save you thousands of dollars over the course of the loan. Find an amortization calculator, look at the interest rates and play with the numbers to get an idea of the savings. Keep in mind that different lenders offer different rates, so you’ll want to shop around when you’re ready.
Here are some ballpark figures for one example:
- 30-year mortgage on a $200,000 loan at 4 percent interest involves interest payments of nearly $144,000.
- 15-year mortgage on a $200,000 loan at 3.75 percent interest involves interest payments of nearly $62,000.
Lower fees — possibly
Closing costs and fees can total several thousand dollars and should be considered in a refinance decision. How much depends on the type of loan you get — a conventional mortgage or a mortgage that conforms to Fannie Mae or Freddie Mac standards, for example. The latter generally offers lower fees for 15-year loans. Work with your lender to find the best deal.
Investment in the home
You are building equity more quickly in your home, and as your home continues to appreciate, the better the investment.
Cons: 15-year vs. 30-year
You pay off the mortgage in half the time
Paying off the mortgage in 15 years gets you out of debt sooner, but may cut you out of 15 years of tax deductions. If you itemize deductions, you can deduct the mortgage interest. No mortgage means no deduction. In addition, on a shorter-term note, such as 15 years, you pay less interest overall, so there is less interest cost to be deducted. Check with your tax advisor.
You will save money long term on interest, but your monthly payments will be larger for the 15 years of the mortgage.
Using our ballpark example from above, payments would be roughly $500 more a month:
- 30-years on a $200,000 loan at 4 percent involves payments of about $955 a month
- 15-years on a $200,000 loan at 3.75 percent involves payments of about $1,450 a month
Cash-flow is crimped
Paying that extra money toward the mortgage ties up a lot more cash every year. That can cut into your emergency cash fund or other opportunities for investments.
Making extra payments
If you have concerns or commitment issues about the higher payments on a 15-year mortgage, there are other options that can strike a comfortable balance.
You can take out a 30-year loan, but make monthly payments like it’s a 15-year note. You’ll pay a higher interest rate, but you’ll still save on interest overall by paying off the loan early. You also will retain the flexibility to skip that extra cash payment in a given month if the money is needed for other uses.
Important note: Make sure your loan has no prepayment penalties, and make sure that extra money goes toward the principal, not the interest.
Work with your lender and financial advisor to come up with the best plan for you.