Is it time to go shorter?
When refinancing into a 15-year mortgage makes sense
With the pandemic still prevalent and interest rates near all-time lows, now is a great time to think about a refinance. It may also be an opportune time to consider shortening your mortgage term in the process.
Many homeowners choose to refinance from a 30-year fixed-rate mortgage to a fresh 30-year equivalent. While this can lower your monthly payment, it can add extra years to the total amount of time you’ll be financing your home. That means you’ll pay more in total interest over the combined terms of your original loan and your refinanced loan than you might expect.
15-year loan can help you save big on interest
Instead, 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.
Yet if you have sufficient cash flow, this strategy can be advantageous, despite the higher monthly payment. Good candidates include homeowners who have lived in their home for several years and have a monthly budget and income that will enable the higher payment while also allowing wiggle room for other expenses, including repairs, maintenance and emergencies. Having extra money set aside for the unexpected is particularly important during the current economic downturn.
Before refinancing into a 15-year mortgage, shop around carefully and compare current mortgage refinance rates from different
lenders.
Advantages of refinancing into a 15-year mortgage
Rajeh Saadeh, a real estate attorney, professor and investor in Somerville, New Jersey, says the benefits of refinancing to a 15-year loan are plentiful.
“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,” he says. “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.”
Paul Buege, president/ COO of Pewaukee, Wisconsin-based Inlanta Mortgage, notes that your monthly payment may not necessarily increase when moving from a 30-year to a 15-year mortgage loan.
“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,” says Buege.
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.
“You may not want to refinance if it will negatively impact your monthly cash flow. That’s especially true in the uncertain financial climate we’re currently in. You have to make sure you can continue to make payments or you could risk losing your house,” cautions William Stack, a financial adviser with Stack
Financial Services LLC in Salem, Missouri.
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.
“I believe that if you’re not maxing out any available employer match to your retirement plan, it’s a mistake to accelerate your mortgage payments by shifting to a 15-year mort