For most home buyers, a 30 year mortgage is the standard choice for financing their purchase. But there’s another option that often goes unnoticed in today’s mortgage marketplace, and it’s an option that could save homeowners tens of thousands of dollars.
30 vs 15 Year Mortgage
With a 30 year home loan, payments are divided across the span of three decades, which helps keep each payment low. The downside to having such a long term loan agreement is that borrowers wind up paying more in the long run, due to interest charges. By contrast, a 15 year mortgage cuts the 30 year loan option in half, ensuring the borrower saves money on interest and enables them to own their home sooner. However, with a shorter-term loan, monthly payments are typically higher. If you’re considering refinancing your mortgage into a 15 year loan, it’s important to review the pros and cons.
15 Year Mortgage Refinance – The Benefits
When you get a mortgage, the lender charges you interest (a fee for the privilege of borrowing money from their institution.) Generally speaking, the longer the loan, the more interest the lender charges. By choosing a shorter term mortgage, the interest you pay over the course of the loan can be dramatically reduced. Let’s use an example to illustrate:
Let’s say you owe $100,000 on your mortgage but your home is worth $130,000. This gives you $30,000 in equity. (Equity is calculated by taking the current market value and subtracting any liens against the property.) If you were to refinance into a 30 year mortgage at an interest rate of 4.00%, your monthly payment would be around $477 (not including taxes, insurance or HOA fees.) Assuming you kept this mortgage and stayed in the home until it was paid off, you would wind up paying $71,869.51 in total interest charges and a loan total of $171,869.51.
Now let’s see the difference 15 years can make.
Since shorter-term loans typically have lower interest rates, we could safely presume that instead of a 4.00% rate, you could get a rate closer to 3.5%. Therefore, if you refinanced your $100,000 mortgage balance into a 15 year loan at a 3.5% rate, your monthly payment would be around $714 (again, taxes, insurance and HOA fees not included.) While this is significantly higher than the payment you’d have with a 30 year loan, the benefit lies in how much you’ll save on interest.
With a 15 year loan at a rate of 3.5%, your overall interest cost will come to $28,678.86 for a loan total of $128,678.86. That’s a savings of more than $43,000!
So to recap…
30 year $100,000 loan at 4.00%
- $71,869.51 in interest
15 year $100,000 loan at 3.50%
- $28,678.86 in interest
15 Year Refinancing – The Drawbacks
The most obvious disadvantage of choosing a 15 year mortgage is the higher monthly payments. For payment-conscious homeowners, this can be intimidating. The last thing any responsible homeowner should do is take on a mortgage they aren’t really capable of repaying. So while the allure of long term savings may compel you to seek a 15 year loan, don’t rush into a decision if you aren’t 100% comfortable with making higher monthly payments.
A more subtle drawback to the 15 year mortgage option is the effect it could have on your other savings. While you may be able to make the higher monthly payment, this could mean less of your money will be available to go into retirement, money market or other savings accounts. Instead, the home itself takes on a bigger role as an investment. If you don’t plan to stick with this investment long-term, why pour a lot more money into it each month? Especially if that money could be better utilized elsewhere?
Looking at it from a different angle, you could argue that building up equity as fast as possible could put you in a favorable position when you decide to sell. If you live in a thriving market and demand is skyrocketing, maybe a short term loan would make sense if you can 1.) afford the payments and 2.) you’re confident you could make a profit by selling within a few years. But the fact remains, you’re banking on a short term payoff when the main selling point to a 15 year mortgage is the long term savings. If this is your strategy, a different loan product may make more sense, such as a 3 or 5 year ARM–but those come with their own unique set of benefits and drawbacks.
The Bottom Line
Ideally, your home will appreciate in value indefinitely, so putting more money into it could really pay off in the long run. This is never guaranteed, but real estate is still considered a fairly stable investment. Since a 15 year refinance allows you to pay more toward your principal balance every month, it can be a great way to bulk up your home’s investment value. By contrast, homeowners who prefer more modest payments, may do better with a longer loan term. To figure out which refinancing option makes the most sense for you, speak with a loan professional serving your area.
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