Mortgage rates have been very low in the last few years, especially for 15 year mortgages. Did you know that you can get a 15 year mortgage these days for under 3% in some cases? That makes refinancing your 30 year mortgage into a 15 year mortgage more tempting, but how do you know when you should do it? This article will shed some light on this very important financial subject.
Why A 15 Year Mortgage
When you are financing your home with a 15 year mortgage, you will always have a higher monthly payment. But you will save big in the long run because you are saving so much in interest costs over a 30 year loan. Also, the rates for a 15 year mortgage will almost always run lower than a 30 year mortgage.
The other reason that some people like to get a 15 year mortgage on a refinance is that after you pay for only 15 years, you are done. You own the house completely. This means that you probably will save hundreds of thousands in interest over the life of the loan.
Here is what to keep in mind when you are weighing a 15 year vs. 30 year refinance mortgage:
- 15 year mortgage: Your first payment is 66% principal and 34% interest.
- 30 year mortgage: Your first payment is 35% principal and 65% interest.
If you have a 30 year mortgage, you will not get the same ratio of principal to interest until year 18.
Another way to think about it: When you get a $230,000 30 year loan, you are going to pay almost as much in interest as the amount of the loan itself! If you convert that into a 15 year loan on a refinance, your total interest paid will only be about $50,000.
How to Know When You Should Refi Into a 15 Year Loan
Obviously, making the decision to refinance into a much higher monthly payment loan is a serious consideration. Here are some things that may make it make sense to do this:
- You are going to be making more money now or in the near future. If you are going to have to pay another $700 per month on your mortgage, you should be certain that you will have the income to support the higher payment. Many people tend to earn more money later in their careers, but you need to be sure that is the case so you are not running into financial issues as you get closer to retirement.
- You want to get the lowest possible interest rate. You will have a higher payment, but it sure is hard to beat a mortgage interest rate as low as 2.5%!
- You plan to stay in the house for the long term. This is very important to consider when it comes to refinancing your mortgage at all. If you plan to leave your home in a few years, your refinance savings may be eaten up with the closing costs of the new loan.
- You want to have your home free in clear faster. Generally, people are better off if they have their house paid off faster. This can make planning for retirement a lot easier if you do not have to worry about a mortgage payment.
Considerations Before Getting 15 Year Mortgage Refi
As you can see in the above illustration, getting a 15 year mortgage can give you major savings in the long run when compared to other loans. However, like most things in life, the program is not for everyone. Naturally, your payments on a 15 year loan will usually be much higher. In some cases, the payment can be 50% higher than a 30 year loan. That type of increase in payment can be a budget killer for many homes.
You also may want to think about getting a 30 year loan because it can be tougher to qualify for a 15 year mortgage as there are higher debt to income requirements. Before you even think about getting a 15 year loan, you should make sure that you can handle the higher payment.
As you are thinking about refinancing, if you decide that a 15 year fixed rate refi has payments that are too high, you do have other options. You still may want to refinance your mortgage because current interest rates are so low. But you can just go ahead and refinance your mortgage into another 30 year loan.
Ask your lender for the lowest possible rate, and even think about getting a zero closing cost loan to save more at the closing table. Then, you can send your lender an extra 50% per month so that you are essentially paying a 15 year mortgage. There is no law against that, as long as your loan does not have a prepayment penalty. This way, you can still enjoy a very low interest rate and you can, on your own, pay a 15 year mortgage.
Naturally, if you have a lean month, such as the house needing a new roof or the transmission going out on the car, you can just pay the regular 30 year mortgage payment if you need to. Note that you will still pay more interest this was than if you actually get the 15 year loan, because you are paying a higher interest rate. Still, you will save hundreds of thousands in interest over a 30 year loan.
For many Americans, refinancing into a 15 year loan makes sense because you will be able to save hundreds of thousands of dollars in interest. This will allow you to plan for an easier retirement because you will no longer have a mortgage payment. But you need to be sure that you can financially handle the higher payments. Weigh carefully what you think your income will look like in the next several years so you are confident that you can make those payments.