Most mortgages start as a 30-year fixed loan. These spread out your principal payments and help to keep your monthly costs low. The downside is you pay interest for 30 years! We’ll look at the benefits of refinancing to a 15-year fixed loan and whether it makes sense for you.
First, let’s define a mortgage (You can read more about mortgages), According to the Consumer Financial Protection Bureau, “A mortgage is an agreement between you and a lender that allows you to borrow money to purchase or refinance a home and gives the lender the right to take your property if you fail to repay the money you've borrowed.”
Refinancing your mortgage means you replace your current with a new one, sometimes changing the terms. "The goal when people refinance is to lower the interest rate and lower the monthly payment and then use the money toward other aims, such as savings,” says Ron Haynie, senior vice president of mortgage finance policy, Independent Community Bankers of America. However, shortening the terms of your mortgage, while increasing your monthly cost, can save you thousands on interest.
There are a number of options when it comes to mortgages, but we’re going to focus on fixed here. Current mortgage rates are moving so we will use examples to showcase how the numbers work. For more information on 4Front offerings and current rates, please contact our mortgage loan officers.
Let’s say we have a $250,000 mortgage with an interest rate of 4%, you would expect to pay $179,673.77 in interest during the life of your loan. That’s roughly $1,193.54 a month for 30 years. Now, if we take that 30 years and make it 15, the same $250,000 and interest rate of 4%, you will pay $82,859.57 in interest. Now, the tricky part is that you will accelerate the payoff which means your monthly payment will go up to $1,849.22 a month. The increase in monthly payment is approximately $655.68. However, you’re looking at saving $96,814.20 in interest (and this math doesn’t include that shortened loans can get you lower interest rates, so your savings could be even greater)! To explore further with your own rates and numbers visit our calculator HERE.
With a shorter mortgage term, you’re paying off your mortgage quicker so you build equity in your home faster, which means more money to improve your property with a home equity loan. You may also qualify for a lower interest rate. A 15-year mortgage is not for everyone though because your payments will be larger. You’ll have less wiggle room in your monthly budget and if that makes you uncomfortable, it may not be the right choice for your situation.
A 30-year mortgage with lower monthly payments allows for more flexibility in your budget when the unexpected occurs, like job changes, financial emergencies, etc. It’s important to carefully consider the impact higher mortgage payments will have on your ability to pay current and unforeseen monthly expenses. You also want to be sure you are saving enough for your retirement. Instead of changing your mortgage, you may want to put more money towards your 401(k) or an IRA account.
Good candidates for a 15-year mortgage are people who:
- Prioritizes debt-free homeownership over saving and investing (or has enough cash flow to do both)
- Can comfortably make the higher monthly payments without sacrificing other financial goals
- Plans on staying put for four years or longer (or at least long enough to break even)
- Can lower their interest rate by at least 0.75%
With all things considered, if your goal is to pay down your mortgage faster, you can do that with a 30-year loan by simply making extra payments whenever you’re able. If you make enough extra payments, you can easily shave time off. The catch with this strategy is that you’ll still pay a somewhat higher interest rate on the 30-year mortgage compared to a 15-year.
Every financial situation is different and we hope this information gives you a starting point as you consider your next steps in homeownership. And, remember, 4Front is here to help with any mortgage or financial planning questions you may have.