Monday, November 26, 2018

Is a 15-Year Mortgage Right for You?

Is a 15-Year Mortgage Right for You?
While taking out a mortgage is both the norm and often the only realistic way to become a homeowner, it can also feel like a huge financial burden.

It’s often one of your biggest monthly bills, making it harder to find room in your budget for other financial goals. And it’s often your biggest debt — with a long payoff period to boot — which can make the goal of becoming debt-free feel remote.

Research shows that carrying debt is a huge drain on happiness and that paying it off is one of the most emotionally satisfying financial moves that you can make.

But that can often feel like an impossible task. Between student loans, auto loans, credit cards and mortgages, it might seem like becoming debt-free is more of a pipe dream than a realistic goal.

There are ways to relieve some of that burden though, and one route to consider is refinancing your mortgage. Specifically, a 15-year refinance can save you a lot of money and help you pay off your biggest debt a lot sooner than expected.

There’s a lot to consider before jumping into a 15-year refinance, and this post will walk you through the pros and cons, as well as what you need to do to prepare for the refinancing process.

Depending on your situation, refinancing to a 15-year mortgage could either improve your financial situation or make it harder to reach your other financial goals.

Here are some of the major factors to consider before making a decision.

1. Lower long-term costs

Jennifer Beeston, VP of Mortgage Lending at Guaranteed Rate Mortgage, points out that there are two factors leading to significant long-term savings from a 15-year mortgage compared with a 30-year mortgage.

The first is the fact that 15-year mortgages generally carry a lower interest rate than 30-year mortgages. Using LendingTree’s mortgage rate tool, a 30-year, $250,000 mortgage in Brooklyn, N.Y., would currently have a 4.25% interest rate for someone would excellent credit. That same mortgage with a 15-year term would only have a 3.75% interest rate.

The second factor is that you’re paying off the loan in half the time. Beeston explains that by paying interest for a shorter period of time, you end up paying a lot less interest overall.

“You are paying less for the house than if you did a 30-year fixed mortgage,” Beeston said. “A shorter period and lower interest rate equal less interest paid to the lender. This results in huge savings.”

Using the example above, someone taking out the 30-year mortgage would pay $192,745.80 in interest over the life of the loan, while someone taking out the 15-year mortgage would only pay $77,249.86 in interest.

That’s $115,495.94 in savings that could be put toward other goals, in addition to getting you out of your mortgage 15 years sooner.

Your specific savings will depend on the current balance and years remaining on your current mortgage, as well as your current interest rate and the rate you could get from refinancing. But in general, the long-term cost savings of a 15-year refinance can be significant.

2. Building equity

One of the other appeals of a 15-year refinance is the opportunity to build equity in your home faster than you would with your current mortgage.

Sticking with the example from above, and assuming a $50,000 down payment, you would have $59,369.29 in home equity two years into your 30-year mortgage. After those same two years with a 15-year mortgage, you would have accumulated $75,798.52 in equity.

That’s an extra $16,429.23 that could be yours if you sold the home, or that you could access through a home equity loan if the need arises.

3. Closing costs will eat into your overall savings

A 15-year refinance isn’t a free lunch. You’re getting essentially a new mortgage and that means paying closing cost fees all over again. You’ll likely have to pay 2% to 3% of the loan amount in upfront closing costs, which may be difficult to afford and can eat into the long-term savings from the refinance.

For this reason, the amount of time you plan to stay in your home can be a big factor in determining whether refinancing is a smart decision. If you plan on moving soon, there may not be enough time for the monthly savings to outweigh the upfront costs.

You can use a refinance calculator to help you run the numbers and figure out just how long you’d have to stay in your home for a 15-year refinance to be cost-effective. In general, the longer you plan on staying, the more likely it is that a refinance will save you money.

4. Increased monthly payments

One of the reasons that the cost savings are so significant with a 15-year mortgage is that your monthly payment is higher than with a 30-year mortgage. With more money going toward the mortgage each month, the loan is paid off quicker and you end up saving money.

But Tyler Landes, CFP®, a fee-only financial planner and the founder of Tandem Financial Guidance, cautions that while the savings are great, you need to consider whether you can actually handle that larger monthly payment.

“Even though it can save money in the long run,” Landes said, “you need to make sure that it’s something you can afford in your budget before locking into a higher monthly payment.”

Sticking with the example above, the monthly payment on the 15-year mortgage would be $1,818.06, as opposed to a $1,229.85 monthly payment on the 30-year mortgage. That’s an extra $588.21 per month, which may or may not be manageable depending on your other expenses.

5. How many years are left on your current mortgage

If you have less than 15 years left on your current mortgage, a 15-year refinance would effectively extend the length of your mortgage and could end up costing you money in the long run.

In this situation, you may be better off simply putting extra toward your current loan, assuming that you wouldn’t face any prepayment penalties. This would allow you to pay your mortgage off quicker without extending your loan term and facing the associated increase in interest costs.

Alternatively, Matthew Roder, VP of Mortgage Banking at BeMortgage, says that executing a 15-year refinance might be ideal when your current mortgage has 17 to 20 years left.

“Due to the lower rate of a 15-year fixed loan,” Roder explained, “the borrower may be able to refinance into the 15-year fixed, keep their monthly payment very close to what it is currently, but pay off their loan two to five years sooner.”

6. Other financial priorities

While paying your mortgage off early is a fantastic goal, and while it has a number of financial benefits, it’s important to consider how a 15-year refinance might impact your ability to reach your other financial goals before jumping in.

For example, are you currently saving enough for retirement? Do you have an emergency fund? What about life insurance or wills? Have you started saving for your child’s college education?

Landes says that focusing on those other goals first, and even focusing on other debts, may be the right move.

“Using surplus cash flow to pay off credit cards, auto loans, and student loans is usually a better use of funds to get started”, Landes said. “Having an emergency fund is essential, and if you have young children, you also must consider term life insurance to provide for them if something happens to you.”

There’s also the question of return on investment. While future returns are not guaranteed, stocks and bonds have generally produced better returns than what you receive from putting extra money toward your mortgage. And many retirement and college savings accounts — such as 401(k)s, IRAs and 529 plans — offer tax breaks that can yield even higher returns.

The bottom line is that the decision to refinance should not be made in a vacuum. You need to consider your entire financial situation and all of the opportunities available to you before you can determine whether a 15-year refinance is the right move.