Smart SpendingSmart Spending

Should you refi to a 15-year mortgage?

With interest rates on a 15-year loan so low, it's tempting to make the switch. Here's what to consider.

By MSN Money Partner Dec 3, 2012 11:10AM

This post comes from Rob Berger at partner blog The Dough Roller.

 

The Dough Roller logoWith mortgage rates at all-time lows, the rate on a 15-year mortgage is really tempting. According to Freddie Mac's survey, the average rate on a 15-year mortgage was just 2.64% last week and 2.63% the week before. That's almost 70 basis points lower than the rate on a 30-year, fixed-rate mortgage.

 

Image: Miniature home on sheet of percent signs © Comstock/Getty ImagesThe really low rates have got me crunching the numbers to see if we should refinance for a third time in a little over a year. But unlike the first two refis, this time I'm considering going from a 30-year to a 15-year mortgage. The decision is not an easy one, and here are some of the factors to consider if you're facing the same question.

 

Your payment will go up.

Even if you can significantly reduce your interest rate with a 15-year note, your monthly payment will likely go up. Let's assume you have a $250,000 30-year mortgage at 5%. Excluding taxes and insurance, your monthly payment would be about $1,350.

 

If you refinanced to a 15-year loan at 2.63%, your monthly payment would go up to about $1,680. (Getting the lowest interest rate available assumes you have a good credit score.)

 

An increase of more than $300 on a $1,350 mortgage payment is significant. But what do you get for the increased payment? The answer is a paid-off home in 15 years while paying a lot less in interest.

 

How much interest will you save?

This one may surprise you. On the 30-year loan described above, total interest is almost as much as the loan itself -- $230,000. Convert to a 15-year loan at the lower rate, however, and the total interest paid drops significantly, to $52,000.

 

The interest drops for two reasons. First, the interest rate has been lowered from 5% to 2.63%. And second, the loan is amortized over just 15 years. But which factor lowers the total interest paid the most? Let's experiment.

 

First, how much would the total interest paid go down if we stuck with a 30-year loan, but could lower the rate to 2.63%? Total interest would be about $110,000. Now, how much would total interest go down if we stuck with the 5% rate, but amortized the loan over 15 years instead of 30? In that scenario, total interest paid would be about $105,000. Not much difference, which suggests that the lower rate and shorter duration both play a significant part in lowering total interest paid.

15- vs. 30-year mortgages

So your payment will go up and your loan duration and interest paid will go down on a 15-year mortgage. If your current rate is 5%, refinancing is very likely a good move. But what about refinancing to a 30-year mortgage. At today's rates, you'd pay about 3.31%. How does the monthly payment and total interest paid at that rate compare with our 15-year option? Here's a comparison table:


 


15-year

30-year

30-year accelerated

Interest rate

2.63%

3.31%

3.31%

Monthly P&I payment

$1,682.32

$1,096.27

$1,682.32

Total interest

$52,816.76

$144,655.51

$72,149.84


As you can see, the difference in payments is significant -- nearly $600. That's a lot of money, particularly if you have any doubt about your future income. And that leads us to the last column in the above table.

 

One option is to refinance to a lower-rate 30-year mortgage, but make payments based on a 15-year loan. I call it the 30-year accelerated mortgage. You'll notice that with this approach you'll still pay more interest than if you refinance to a 15-year loan. Why? Because your interest rate is higher. But you still pay a lot less interest than the standard 30-year note. And you have the flexibility to make the lower payment if your income declines or you need to use the extra cash for something else.

 

Taxes

Taxes should always be a consideration when evaluating mortgage options. Assuming you itemize your deductions, you will generally get a tax deduction equal to your marginal tax rate times the mortgage interest you pay. When determining your marginal rate, be sure to include any state income tax you must pay.

 

A comparison of the 15-year and 30-year accelerated options above shows a difference in total interest paid of about $20,000. If your marginal rate is 30%, however, the real difference is about $14,000 after taxes ($20,000 x (1 – 0.3).

 

It's the combination of tax benefits and the lower payments of a 30-year mortgage that have kept me away from a 15-year loan. But with rates so low, it's very tempting to make the change.


If you have refinanced from a 30-year to a 15-year loan, leave a comment and let us know why you made the switch.

 

More on The Dough Roller and MSN Money:

10Comments
Apr 8, 2013 2:17PM
avatar
My wife and I are currently 2.5 years into a 150,000 (30 yr @ 4.25%) mortgage with a balance  of $128,000.  If we paid the balance out as scheduled, we would pay around $90K in interest - that makes me sick.  We have been adding $180 toward the principal to each payment (bringing our monthly payment up to $1200).  By doing this we shaved 9 years from the term and cut the interest to $56K - I'm still nauseated. We have decided to refinance to a 15 year @ 3.00%.  Our monthly payment will pan out to be approximately ($1200) so we will feel no change, except cutting an additional 4 years and bringing the interest paid down to around $31K - That is still Toyota Tundra's worth but I am feeling somewhat better.

A lot of people advise to not pay the mortgage off as soon as possible and instead take advantage of 30 years, the low interest rates and invest the difference. That doesn't always play out to be the best decision and it doesn't in our case either.

While (key word) we are adjusting our mortgage, my wife and I are also taking full advantage of our employer match, diligently maxing out our Roths each year, we have opened a taxable investment, and are building a healthy EF. We manage our CCs by never charging more than we can pay off on a given month. Our only other debt is $22K for student loans and a small home addition.  By having our house paid off by our mid 40s, we will have half of our working careers left to now add what we are not paying on the home into our investments - or wherever.  Any head start we would have made by investing that $180 a month for 15 or 30 years will be quickly over shadowed by investing the increase in savings w/o having a mortgage (minus repairs, upkeep etc....which obviously will be expected no matter what).  And this is especially true when you calculate in the savings of the interest which has kept me so sick.

And to squash the notion that my wife and I are ultra wealthy - well we are by world's standards - but neither of us make more than $20 an hour.  We have a strong budget and drive used cars which we own outright, I do most of the repair work, we take camping trips as vacations and subscribe to Netflix, as our cable TV. Moderation is the name of the game - that is the ticket to our success.
Dec 3, 2012 9:58PM
avatar
I refied my 30-year 5.25% (that I had bought in 2010 for 233K, financing 210K) to a 3.25 15-year in May, but I also paid down another 20k to reduce my monthly payments. My original payments (without taxes, which are 500/month here in TX) were 1120 but now I'm paying 1309, 190 more per month. The interest + extra down payment helped make the monthly payment not to high. While I'd love to reduce my payments by refying to a 30-year, I'm 41 and eligible to retire at 55, which would be feasible with the house paid off! So I'm sticking to the 15-year.
Jan 9, 2013 11:18AM
avatar

I have refinanced from 30 year fixed 3.875% to a 15 year fixed at 2.5%. My payment went up by $600/Month, but the initial amount goes to principal increased by $920/Month. Basically saying I am putting $600 every month in the house and getting $320 for that investment (53% rate of return). I don't think any investment can yield that outcome. Although I can’t take that Investment Earnings right away until I refinance again or sell my house.  Only shortcoming of this refinance is that it is difficult IF my income go down in near future, but it will not likely to be the case.

Dec 3, 2012 11:44PM
avatar
I've lived in my home for 6 years.  I've re-fied twice already, always from a 15-yr to another 15-yr.  I currently have a 3.8% but I can go to a 2.8% with no increase in my payment and about $250 in costs.  Additionally I can take out about $12,000.  That's a maximum Roth contribution for both my wife and I.  I think this makes sense but I just want to be sure.
Dec 5, 2012 2:19AM
avatar
I refinance to 15 last year with a rate of 3.125.  I am considering going back to a 30 because of the tax advantage, safety net and most importantly, my adviser says I'll make a buttload more than the interest savings by investing the offset.
Report
Please help us to maintain a healthy and vibrant community by reporting any illegal or inappropriate behavior. If you believe a message violates theCode of Conductplease use this form to notify the moderators. They will investigate your report and take appropriate action. If necessary, they report all illegal activity to the proper authorities.
Categories
100 character limit
Are you sure you want to delete this comment?

DATA PROVIDERS

Copyright © 2014 Microsoft. All rights reserved.

Fundamental company data and historical chart data provided by Morningstar Inc. Real-time index quotes and delayed quotes supplied by Morningstar Inc. Quotes delayed by up to 15 minutes, except where indicated otherwise. Fund summary, fund performance and dividend data provided by Morningstar Inc. Analyst recommendations provided by Zacks Investment Research. StockScouter data provided by Verus Analytics. IPO data provided by Hoover's Inc. Index membership data provided by Morningstar Inc.

ABOUT SMART SPENDING

Smart Spending brings you the best money-saving tips from MSN Money and the rest of the Web. Join the conversation on Facebook and follow us on Twitter.

VIDEO ON MSN MONEY

TOOLS

More