Should You Refinance from a 30-Year to a 15-Year Mortgage?

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:

 15 Year30 Year30 Year Accelerated
Interest Rate2.63%3.31%3.31%
Monthly P&I Payment$1,682.32$1,096.27$1,682.32
Total Interest$52,816.76$144,655.51$72,149.84

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

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.

Published or Updated: November 29, 2012
About Rob Berger

Rob founded the Dough Roller in 2007. A litigation attorney in the securities industry, he lives in Northern Virginia with his wife, their two teenagers, and the family mascot, a shih tzu named Sophie.

Comments

  1. Grant says:

    I did refinance from 30 years loan to 15 years loan. In my case, the payment only went up by 100 dollars. How is that possible, you asked? I bought the house in 2007, which was right before when the housing market went into the twilight zone. In 2007, I got 7% for 30 years and I refinanced it last year to 2.75% for 15 years. What is amazing is that I only knocked off $1,000 from principle when I was paying the 30 years loan. I knocked off $9,000 in one year with the 15 years loan. WOW!!!

    I made the switch to for two reasons. One is to build up the equity as I plan to move. Second is to try to pay off the house before my kids go to college. That way I can help pay their way through college.

    • Great job Grant. Most people don’t realize how much interest and how little principle they are paying on a 30 year mortgage. Keep it up, you’ll have that mortgage dead before you know it.

    • Rob Berger says:

      Grant, that’s a win-win. Thanks for sharing your experience.

  2. Maggie says:

    We refinanced nearly 2 years ago from a 30 to a 15– $265k loan at 4.5%. At that time, we rolled our 2nd mortgage into the loan (its rate was 6.75, 15 years). Just trying to tackle the overall debt. The higher payment was workable, as we are blessed with two steady jobs. Pulled the trigger again this week and refi’d the 15 to a 2.75 rate. Payment decreased by $500/month due to the much lower balance as a result of paying down the principle much faster on the 15y. Yes, our term is starting over, but my hope is to accelerate payments (keep them the same) which will make it 10y 8m remaing…. shortening our actual term under the previous 15y by about a year and a half. Would love to have no mortgage payment by the time we retire…. the ultimate goal.

    • Rob Berger says:

      Maggie, it sounds like you’re on your way to being mortgage-free! It’s just that interest rate that is tempting me right now. I just don’t know if I can talk my wife into a third refi in less than a year!

  3. Money Beagle says:

    The most important thing that I think people don’t understand is that while your payment goes up, what goes up even more is your equity in your home. If your payment goes up by $150 a month, that’s $150 more in cash you have to pay, but you could be paying $400 more in principle a month. So that $150 is getting you a ‘bonus’ net worth boost of $250 per month. That’s huge and adds up big over the life of the mortgage.

  4. David S says:

    We refinanced our 2 year old 30 FHA 4.5% mortgage into a 15 year conventional 2.5% mortgage and the total payment stayed the same. The reason was that the slight increase in the P&I was offset by the removal of MIP that was part of the FHA loan. So instead of paying the mortgage insurance it goes towards our principle.
    The reason for the refinance though is that we want to be out of all debt ASAP and the mortgage is the last of our debts to tackle. Also the retiring of the mortgage will coincide with our eldest entering college so we will be able to provide a “scholarship” for him to get his higher education.

    • Rob Berger says:

      David, I wish every visitor to this site would read your comment. It’s an excellent plan. And for those wondering about MIP, it’s mortgage insurance required on FHA loans. You can get some idea of it here.

  5. Jordan says:

    To save that much interest definitely seems to be a good idea. We can afford the extra few hundred to save thousands over time. I never thought of refinancing to a 15 year mortgage but now I’ll look into it.

  6. dusty rhodes says:

    On the surface, paying off a mortgage by a 15 year loan as opposed to a 30 year
    loan seems very wise given the conventional wisdom that says one ought to pay
    off a mortgage as soon as one possibly can. The question I would pose is do we
    tyically give any thought to how useless dead equity in a paid off home really is.
    Yes it is nice to be without a payment. Natural disasters such as mud slides which
    have taken people’s homes in California or hurricanes which have taken peoples
    homes along the eastern seaboard, or earthquakes which have damaged peoples
    homes beyond repair, which in many cases have resulted in a total loss because
    hazard insurance didn’t cover many or most of these situations, in hindsight didn’t
    turn out to be a very wise move. It is possible today to purchase rental homes
    at a discount of from 15-40% today because of the mortgage mess of recent years.
    Would it not be more prudent to take significant equity out of a home, buy two
    discounted homes, and make 3 times the annual principal savings by just re-
    financing a principal residence. Many people today are increasing net worth
    exponentially by parlaying what they could use to pay down a principal mortgage,
    whatever the vehicle, and instead using an equity outside for more profitable
    investments. Different baskets spreads out one’s risk and if appreciation ever
    comes roaring back the result could be phenomenal.

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