If you're one of the millions who have decided to refinance to
take advantage of record-low
, you would be remiss if you didn't also consider refinancing to a
Refinancing your 30-year mortgage into a 15-year loan might mean
a higher monthly payment, but it will allow you to save thousands
on interest and pay off your mortgage much sooner. Not only does
the shorter term mean fewer interest payments, 15-year loans have
significantly lower interest rates than their conforming
"Borrowers could obtain even lower rates by choosing a
15-year fixed-rate mortgage
, which averaged below 2.93 percent in 2012," says Leonard Kiefer,
deputy chief economist at mortgage giant Freddie Mac in McLean, Va.
"This was the lowest annual average for the 15-year fixed-rate
mortgage since we began keeping track of the product in 1991."
"HSH.com has tracked 15-year fixed-rate mortgages since early
1986," says Keith Gumbinger, vice president of HSH.com. "These are
not only record lows, but are less than half the interest
rate available as recently as 2008, and, remarkably, more than
eight percentage points below those 1986 rates. It would be hard to
imagine a better time to take one of these short-term loans."
Those rock-bottom mortgage rates have made shorter-term loans
A recent Freddie Mac report
found that 27 percent of borrowers who refinanced in the fourth
quarter of 2012 shortened the term of their loan, while 69 percent
kept the same term and only 4 percent lengthened the term.
To understand how a shorter-term loan saves you money over the
long term, compare a 30-year, $200,000 loan at 3.5 percent, to a
15-year, $200,000 loan at 2.9 percent. The monthly payment on the
30-year term was $898 and with a total interest expense of
$123,312. The 15-year loan has a monthly payment of $1,371 and a
total interest expense of $46,881. The monthly payment is $473
higher for the 15-year term, but the interest saved amounts to
While borrowers traditionally don't select 15-year loans for
purchases due to steep price increases, refinancing older mortgages
to shorter terms tends to have smaller increases, or sometimes
no change in the monthly payments at all, adding to the
incentive, says Gumbinger.
So, what are the pros and cons of a shorter-term mortgage?
In addition to the lower interest expense, the other major
upside is the opportunity to build equity faster and own your home
outright sooner, a goal that might be especially attractive if
you're nearing retirement.
"There's a big incentive for a large portion of younger Baby
Boomers to take advantage of these record low rates by
transitioning from a 30-year fixed to a 15-year fixed-rate mortgage
when they refinance because it provides them an opportunity to own
their home free-and-clear based on their retirement planning,"
The downside is the higher payment, though that might be less of
a leap than you'd imagine if your current loan has a high interest
rate or you've paid down a chunk of your initial loan amount, says
Justin Lopatin, vice president of mortgage lending at PERL
Mortgage, a mortgage company in Chicago.
"When you refinance, you're borrowing the amount you currently
owe, so you are restarting at a lower amount," Lopatin says. "For
some people, there may not be a huge swing in payments because
they've paid down so much of that balance."
Prepaying provides more flexibility
A compromise is to get a 30-year loan, then commit yourself to
making higher payments or extra payments to reduce your principal
more quickly. This strategy sacrifices the lower rate, but still
builds equity faster.
"The conversation I'm having with people more often is 'Go ahead
and get the 30 and you can control how you pay it off as if it was
a 15-year mortgage. That's what I actually recommend," says Gary
Parkes, vice president of mortgage lending at Guaranteed Rate, a
mortgage company in Atlanta, Ga.
However, taking a 30-year mortgage instead of a 15-year
does mean you don't get the lower interest rate commonly offered on
the shorter-term product. You will preserve flexibility, but at a
cost, says Gumbinger.
"You can actually prepay your mortgage into any term you like by
Its My Term Prepayment Calculator
Flexibility is important in case you later become cash-strapped,
perhaps due to a job loss or reduced income and can no longer
afford the higher monthly payment.
The big picture
You should have a healthy emergency savings fund before you
devote extra money to paying off your mortgage, Parkes adds. One
reason why that's smart is that home equity credit lines of credit
aren't as readily available as they once were.
"I tell people to look at their whole situation, not just 'I
want to get the mortgage paid off.' Look at all the factors," says
Lopatin also emphasizes the importance of a big-picture
approach. If you're planning to move or increase your household
expenses within a few years or if you have another use for the
money, a shorter term might not be the right choice.
"Does it make sense to spend more on your mortgage or does it
make sense to leverage your mortgage, your (tax) write-offs and
your equity and redirect that extra money into some type of
investment?" he says. "For most people, a hundred dollars up or
down can be significant."
The only way to know if you can afford to refinance to a 15-year
mortgage is to run the numbers through HSH.com's mortgage
calculator to find out how much higher your payment would be.