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Mortgage rates are rising again. But they’re still pretty low historically. And rates on a 15-year mortgage are even lower than rates on a 30-year mortgage. Freddie Mac’s average 30-year mortgage rate for October 2017 was 3.90%. But you could get a 15-year mortgage for 3.20% or even less (see current interest rates here).
The spread doesn’t seem like a lot. But with the lower interest rate and a shorter repayment term, you’ll pay much less interest over time. Still, that’s not the only factor to consider when deciding whether to refinance from a 30-year to a 15-year mortgage. Here are other things to keep in mind:
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 say you have a $250,000 30-year mortgage at a 4% APR. Your monthly payment, excluding taxes and insurance, should be about $1,193 per month.
Now what happens if you refinance to a 15-year mortgage at 3.3% interest? You’ll wind up with a $1,762 per month payment. That’s a $569 difference each month!
Now, that additional payment may be worthwhile. After all, you’ll pay off your mortgage in half the time without nearly doubling your monthly payments.
But before you take the leap, consider what that increased mortgage payment may do to your budget and investing opportunities, including:
- Reducing flexibility in your budget. If your budget is at all tight, moving up in mortgage payments may not make sense. Sure, you’ll pay off your home faster. But for the next 15 years, you may struggle to just pay the mortgage each month. That’s not a good way to live or obtain financial freedom.
- Reducing your ability to pay off other debts. If you’re still working towards debt freedom, what will an increased mortgage payment do to this? It may be better to put that $569 towards high-interest credit card debt. Once you’ve cleared these obligations, then consider refinancing to a shorter mortgage term.
- Reducing your ability to invest. What if you’re in a great financial position, with more income than you need and no high-interest debt? Even then, refinancing may not be the best option. If you’re a steady saver and a good investor, you can probably get a higher return on that $569 per month than the few percentage points you’ll save. This doesn’t always work out, of course, but it’s something to consider (here’s our guide on how to invest).
How Much Interest Will You Save
With all that said, looking at the overall savings for this refinance scenario may sway you to take the financial leap. You can run your numbers through this loan calculator to find out exactly how much interest you’ll pay in either situation.
For example, let’s look at the hypothetical loan situation above. The first loan is a $250,000 30-year loan at 4% interest. On this loan, the total interest paid would be $179,673. That’s a huge amount of money!
But if you convert it to a 15-year loan at 3.3% interest, you’ll only pay $67,295 in interest over that 15 years. That’s a savings of $112,378. Not exactly pocket change!
Lowering the rate and the repayment term can save you serious cash over the life of your loan. And that’s what makes it seem like refinancing from a 30-year to a 15-year mortgage is a no-brainer.
But don’t start shopping for a 15-year mortgage just yet. Read on to find out how taxes may mess with your calculations.
What About Taxes?
Before you make your refinancing decision, be sure to take taxes into account. If you don’t itemize your tax deductions, this won’t matter much. And depending on the way the planned future tax reform goes, it may become a moot point.
But for now, when you itemize as a homeowner, you’ll usually get a tax deduction equal to your marginal tax rate times the mortgage interest you pay. Be sure to include any state tax income you pay in your marginal tax rate.
Let’s say your marginal tax rate is 30%. Remember we said the difference in total interest paid between our hypothetical mortgages is $112,378? If you take taxes into account, the real difference is more like $78,664 ($112,378 – (1-.3)).
That’s still a lot of money, of course. But it’s less than it seems at first blush.
So at this point, it looks like we’ve muddied the waters more than actually answered your question. So let’s talk through some specific situations where refinancing may or may not be the best route.
Scenario 1: Your Mortgage Interest Rate is High
What if you still haven’t taken advantage of the relatively low-interest rates of the last decade or so? In this case, it may make sense to refinance to a shorter-term loan as soon as possible. In fact, you may even wind up with a much smaller payment!
This may also be the case if you’ve only been a homeowner for a few years but first obtained your mortgage with less than stellar credit. If your increased credit score qualifies you for a lower rate, shop around. You may find a 15-year mortgage has a payment equal to or below what you’re currently paying on your 30-year mortgage. This can be the case if you are significantly dropping your interest rates.
So if you’re currently in a 30-year mortgage with an above-average rate, you should definitely shop around to refinance. And you may even find you can get into a shorter-term without laying out much more cash each month.
Scenario 2: You’d Rather Invest
What if you want to invest in something other than your home? As long as you’re paying a relatively low mortgage interest rate, that can be a viable option.
Let’s say you scope out the above refinance, but decide not to do it. Instead, you steadily invest that $569 per month for the life of your existing 30-year mortgage. If you earn an estimated annual interest rate of 8%, you could have $848,014 in the bank by the time your mortgage is paid off. (That doesn’t, of course, take taxes into account. So be sure you do that math.)
What if, instead, you decide to take the higher payment and get out of your mortgage in 15 years? In this case, you decide to just invest the whole $1,762 mortgage payment for 15 years after your mortgage is paid off. That might seem better because you’re investing more money, right?
However, when you’re dealing with compound interest, time is a huge factor. So in this case, earning 8% interest, you’ll only wind up with $609,719. If you’re consistent with your investments, you could come out on top. Of course, the market will play into these considerations, and you could lose money rather than more quickly building equity in your home.
Scenario 3: You’re Not a Disciplined Saver
What if you have the extra money in your budget, but you’re prone to spending it rather than saving beyond the minimum? In this case, a 15-year mortgage could be a good choice. It’s a sort of forced savings. Maybe you’re not getting a great return on your investment. But it’s better than frittering away that $569 per month, for sure.
Just be sure that you really do have the wiggle room in your budget, and the steady income, to comfortably make the increased mortgage payments. Otherwise, a small financial bump in the road could cause serious financial repercussions.
As with all things personal finance, the decision of whether or not to refinance from a 30-year to a 15-year mortgage is just that: personal. Just make sure you look at the actual math rather than jumping to conclusions about the best option.