With mortgage rates once again at an all time low, the rate on a 15-year mortgage is really tempting. According to Freddie Mac’s weekly survey, the average rate on a 15-year mortgage is just 2.63%. And that’s almost 70 basis points lower than the rate on a 30-year fixed.
And the really low rate has got me crunching the numbers to see if we should refinance for a third time in a little over a year. But unlike the first two refi’s, this time I’m considering going from a 30-year to a 15-year mortgage. The decision is not an easy one, and here are some of the factors to consider if you’re facing the same question.
Your Payment Will Go Up
Even if you can significantly reduce your interest rate with a 15-year note, your monthly payment will likely go up. Let’s assume you have a $250,000 30-year mortgage at 5%. Excluding taxes and insurance, you monthly payment would be about $1,350. If you refinance to a 15-year loan at 2.63%, your monthly payment will go up to about $1,680.
The interest rates used in the calculations are the best rates available today, which means you need a good credit score to qualify. To understand how credit scores affect mortgage rates, check out this article on what credit scores are need to buy a home.
A more than $300 increase on a $1,350 mortgage payment is significant. But what do you get for the increased payment? The answer is a paid off home in 15 years while paying a lot less in interest.
How Much Interest Will You Save
This one may surprise you. On the 30-year loan described above, total interest is almost as much as the loan itself–$230,000. Convert to a 15-year loan at the lower rate, however, and the total interest paid drops significantly to $52,000.
The interest drops for two reasons. First, the interest rate has been lowered from 5% to 2.63%. And second, the loan is amortized over just 15 years. But which factor lowers the total interest paid the most? Let’s experiment.
First, how much would the total interest paid go down if we stuck with a 30-year loan, but could lower the rate to 2.63%? Total interest would be about $110,000. Now, how much would total interest go down if we stuck with the 5% rate, but amortized the loan over 15 years instead of 30? In that scenario, total interest paid would be about $105,000. Not much difference, which suggests that the lower rate and shorter duration both play a significant part in lowering total interest paid.
15 Versus 30-Year Mortgages
So your payment will go up and your loan duration and interest paid will go down on a 15-year mortgage. If your current rate is 5%, refinancing is very likely a good move. But what about refinancing to a 30-year mortgage. At today’s rates, you’d pay about 3.31%. How does the monthly payment and total interest paid at that rate compare to our 15-year option? Here’s a comparison table:
30 Year Accelerated
|Monthly P&I Payment||$1,682.32||$1,096.27||$1,682.32|
As you can see, the different in payments is significant–nearly $600. That’s a lot of money, particularly if you have any doubt about your future income. And that leads us to the last column in the above table.
One option is to refinance to a lower rate 30-year mortgage, but make payments based on a 15-year loan. I call it the 30-year accelerated mortgage. You’ll notice that with this approach you’ll still pay more interest than if you refi to a 15-year loan. Why? Because your interest rate is higher. But you still pay a lot less interest than the standard 30-year note. And you have the flexibility to make the lower payment if your income declines or you need to use the extra cash for something else.
Taxes should always be a consideration when evaluating mortgage options. Assuming you itemize your deductions, you will generally get a tax deduction equal to your marginal tax rate times the mortgage interest you pay. When determining your marginal rate, but sure to include any state income tax you must pay.
A comparison of the 15-year and 30-year accelerated options above shows a difference in total interest paid of about $20,000. If your marginal rate is say 30%, however, the real difference is about $14,000 after taxes ($20,000 x (1 – .3)).
It’s the combination of tax benefits and the lower payments of a 30-year mortgage that have kept me away from a 15-year loan. But with rates so low, it’s very tempting to make the change.
If you have refinanced from a 30-year to a 15-year loan, leave a comment and let us know why you made the switch.