Today’s low rates should be enough motivation for most people to refinance if they haven’t for the past six months or so. And for some holders of 30-year fixed-rate mortgages, it’s a question of taking the extra mile or in this case, of refinancing to a 15-year fixed-rate mortgage. »Shop and compare rates»
Interest + Principal Do Make a Mortgage
Interest rates on 15-year fixed-rate mortgages are usually lower than 30-year fixed-rate mortgages. Freddie Mac’s weekly mortgage rates survey for the week ended 8 September 2016 reported an average of 2.76% for 15-year FRMs and 3.44% for 30-year FRMs.
With 15-year FRM rates normally lower plus the current historically low rates, refinancing into a 15-year FRM does take a big chunk out of interest payments. For some, it could mean savings in interest of as much as the total amount loaned itself!
You see, a 15-year mortgage allocates more on the principal and less on the interest. This explains why payments on 15-year FRMs are higher compared to 30-year FRMs. You also build equity faster this way. And by the time you made your 180th payment, you are debt-free.
A 30-year mortgage, on the other hand, allocates less on the principal and more on the interest. With its stretched-out term, payments initially go toward the interest and then become heavy on the principal later on. This makes payments on 30-year mortgages lower and more affordable.
For Whom is a 15-Year Mortgage for?
For all its low-interest rate and shorter term, refinancing into a 15-year mortgage certainly is a saver’s dream. But, as most experts warn, it’s not for everyone.
First, you have to take into account the increase in payments. This can hurt those who have gotten used to making low mortgage payments every month on their 30-year mortgages. For homeowners with a tight budget, it certainly poses a problem. So, ideal candidates for 15-year mortgage refinance are those with:
- a steady flow of income, or
- extra income.
Second and related to income is debt-to-income ratio. DTI measures how much of your monthly gross income goes to debt servicing. An acceptable ratio is said to be 28/36, that is 28% is to be paid to housing-related costs like mortgage and 36% is to be paid to housing-related costs and other recurring debt. And because a 15-year mortgage means higher payments, an addition to your monthly expense, lenders would consider how you’d be able to manage your debt.
Third, consider how much you’ve paid on your 30-year mortgage. If you’re half way into repaying your loan, it might not make financial sense to refinance and take on costs associated with it. It also won’t make much sense to do a refinance and move out of the house in two years or so. The refinancing costs will definitely outweigh the savings from the refinancing.
If a 15-Year Is a No, What to Do?
Even if you can’t afford to refinance into a 15-year mortgage right now, you still have a myriad of options. There is the 18-year, 20-year, or even 30-year loan. You can refinance into a 30-year loan and pay it off in the same way as a 15-year loan. Just ask your lender if there’s a prepayment penalty.
Why wait, talk to any of our lenders and find answers to your questions about refinancing. »Start here!»
Justin McHood is America's Mortgage Commentator and has been providing expert mortgage analysis for over 10 years.