With the economy weakened by COVID-19, the Federal Reserve lowered the federal funds rate earlier this year in an effort to help bolster it. This move created low interest rates for mortgages, causing home buyers and homeowners alike to take advantage.
While buyers were able to purchase a home with a lower interest rate on their loan, homeowners with current mortgages were able to lower their monthly payment or switch to a shorter term with a refinance.
If you currently have a 30-year mortgage and you’re looking at refinance options, you may be wondering if you should refinance to a 15-year mortgage. While there may be some benefits of refinancing to a 15-year fixed loan, it’s important you consider your situation and your financial goals to determine if it’s the right option for you.
What Does It Mean To Refinance To A 15-Year Mortgage?
Refinancing replaces your old mortgage with a new one that comes with different features. Those new features could include a different interest rate, payment schedule or loan terms. Your new mortgage pays off the old one and still uses your home as collateral.
There are a few reasons people may opt for a 15-year mortgage when they refinance.
When you refinance from a longer term loan, say a 30-year mortgage, to a 15-year, you shorten the amount of time you have to pay off the loan – in this case, by half.
When you refinance from an adjustable rate mortgage (ARM) to a 15-year fixed loan, you’re changing the terms of your loan by going from an interest rate that changes (after the fixed period expires) to one that remains the same through the life of your loan.
ARM Vs. Fixed-Rate Mortgages
Switching from an ARM to a fixed-rate mortgage provides stability and predictability. You’ll always know what your interest rate will be. This can help with budgeting because your monthly payment on your principal balance and interest won’t change. It can also provide peace of mind that you won’t be paying more if rates increase.
While the advantages are tempting, consider how long you’ve had your loan and how long you plan on keeping it. ARMs typically start with a fixed rate for a specific amount of time, usually 5, 7 or 10 years. Should you refinance to a 15-year mortgage before that time is up, you could end up paying more in interest, since fixed-rate loans have higher interest rates. If you’re thinking about refinancing to a 15-year loan from an ARM, consider waiting until after your fixed-rate period ends. If you’re not planning on living in the home long after it ends or plan on moving before it ends, you may not want to refinance.
Another thing to consider is the costs of refinancing.
Average Costs Of Refinancing
As with any loan, a refinance may come with certain fees, including:
- Application fee
- Credit report fee
- Appraisal fee
- Recording fee
- Title search and insurance
While the costs will vary depending on your loan and lender, you can expect to pay about 2% – 3% of your loan balance. For example, if you refinance to a $200,000 loan, you can expect your closing costs to be around $4,000 – $6,000.
If you’re considering refinancing to save money, keep in mind the costs to refinance. How long will it take for you to recoup these expenses? Will you stay in the home long enough for that to happen? If not, you aren’t actually saving money.
How To Decide If Refinancing To A 15-Year Mortgage Is Right For You
Should you refinance to a 15-year mortgage? Again, that depends on your situation. If you’re trying to save money right now, you’ll want to compare costs and do the math to make sure you’re actually going to accomplish that – especially if you don’t plan on staying in the home for a long time. If you’re looking to save money in the future and plan on living in your home for many years to come, refinancing to a 15-year may be a good option for you.
Here are a few ways decide.
Compare Interest Rates
If you’re looking to lower your interest rate, make sure you compare your current interest rate with the new one you’ll potentially receive with a refinance. Fifteen-year mortgages often have lower interest rates than 30-year mortgages but may still come with higher monthly payments.
Because of the Federal Reserve’s rate drop, you’ll likely get a lower interest rate when you refinance your loan. However, because your payment may increase by shortening your term, it may not feel like much of a win. If you currently have a 30-year mortgage and your main goal is to drop your interest rate to lower your monthly payment, you may want to consider refinancing to another 30-year.
Remember that several factors go into determining your interest rate, like credit score. The best way to get an estimate of what your new interest rate could be is to talk to a mortgage expert.
Calculate Long-Term Savings
If your main goal is to pay less interest over the life of the loan, switching to a 15-year mortgage may be the right option. However, you’ll only see the benefits if you stay in the home for at least 15 years.
Here’s a basic example:
Let’s say you have a 30-year mortgage with a current loan amount of $400,000 and an interest rate of 2.99%. You’ve had this mortgage for 5 years and have 25 years left to pay it off. If you refinance to a 15-year mortgage and, for simplicity’s sake, keep the same interest rate, you’ll save about $71,700 in interest over the life of the loan. However, your monthly mortgage payment will go from about $1,895 per month to about $2,760 – about $865 more. This calculation doesn’t include refinance fees, either.
The great news is, you’ll save thousands of dollars on interest and own your home free and clear 10 years sooner. However, you’ll have to sacrifice hundreds of dollars more each month until your loan is paid off.
Decide Whether You’re Ready For Higher Monthly Payments
As you can see in the example above, monthly payments may increase dramatically.
The example we used was a very basic one in which the loan term dropped 10 years and the interest rate stayed the same. Your situation will be completely different. For example, you may not shorten your loan term as much by refinancing to a 15-year. It’s also highly likely that your interest rate will not stay the same. To help with calculations specific to your situation, try a refinance calculator.
If your monthly payment is estimated to increase by switching to a 15-year mortgage, it’s important to think carefully about whether there’s room in your budget to afford that payment. If you don’t think you’ll be able to make that required payment every month – and do so comfortably – you may want to reconsider. Remember, you can still pay off a 30-year mortgage early. You can still make higher monthly payments to do so, you just won’t be required to pay that much off each month. That can give you peace of mind, should you have a rough month financially.
It’s important to remember that calculations will differ for each homeowner. Every borrower will have a different loan amount, interest rate, financial goal and amount of time they wish to stay in the home. These factors all play into the decision to refinance to a 15-year mortgage or not.
Of course, when dealing with financial goals, it’s best to talk to your financial advisor, who can offer assistance based on your individual situation. It’s also helpful to talk to a mortgage expert to learn more.