When does refinancing into a 15-year mortgage make sense?
refinance mortgage rates from different lenders.
What’s the difference in payments for a 15-year versus 30-year mortgage? The minimum monthly payment on a mortgage is the amount required to be paid in full each month. As the minimum payment for a 30year mortgage will be lower than that of a 15-year mortgage, this allows more flexibility within your monthly budget. That can come in handy if your income changes, you lose a job or you have financial emergencies to cover.
When considering converting to a 15-year mortgage, homeowners should carefully consider the impact on their finances. You should evaluate the impact on your ability to pay monthly expenses, and how the higher payment will affect your capacity to pay down debts and invest — compared to your current scenario with a 30-year mortgage.
If your goal is just to pay down your mortgage faster, you can do that with a 30-year loan by simply making periodic extra payments. If you make enough extra payments over your loan term, you can easily shave off time from your loan, even 15 years if you desire.
The catch with this strategy is that you’ll still pay a somewhat higher interest rate on the 30-year mortgage compared with a 15-year loan. You also need to earmark extra mortgage payments to go specifically toward paying down your loan principal.
Let’s look at an example of how a lower interest rate and shorter loan term impacts the principal amount of a mortgage.
A homeowner with a 30-year $200,000 mortgage can pay it off in 15 years by adding $524 to each monthly payment.
With a 30-year mortgage, you can skip the extra $524 payment any month you want if you lose your job or have an emergency expense to cover.
A 15-year mortgage with a higher minimum payment, however, doesn’t give you that flexibility.
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.
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.
“Mortgage debt is lowcost debt, and pouring more money into an illiquid asset — your home — may do more to limit your financial flexibility than enhance it,” says Greg McBride, CFA, Bankrate’s chief financial analyst. “Money in the bank will pay the bills; home equity will not.”