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Currently locked into long-term mortgage financing, such as a 30-year home loan that you closed on in recent years? You may want to consider refinancing to a shorter-term mortgage, such as a 15-year home loan. Doing so can save you thousands otherwise spent on interest and help you accrue home equity more quickly.
But the timing has to be right for this refi. And your financial house should be in order. Learn more about how a 15-year mortgage loan works, the benefits and drawbacks to refinancing to a 15-year loan, worthy prospects for refinancing, if you should consider an adjustable-rate refi, and the process and closing costs involved.
How a 15-Year Mortgage Loan Works
Mortgage loans can be had for a variety of different set terms, depending on the loan program. Conventional loans can be repaid over 30, 25, 20, or 15 years, or for even shorter terms if the lender allows it. Non-conventional government-backed loans, meanwhile, usually come in two flavors: 30-year or 15-year loans.
Your term dictates how your loan will be amortized – in other words, how your payments will be spread out over the agreed-upon repayment period/term.
“Most people take out a 30-year loan because it keeps their payments lower, with the principal loan balance amortized over 30 years,” explains Mason Whitehead, a Dallas-based branch manager for Churchill Mortgage. “Your amortization schedule, however, is not necessarily a straight line where you take the loan amount divided by 30 years.
It is heavily weighted toward repaying the interest you owe in the early years of the loan, then repaying the principal you owe in the later years of the loan. Consider that, on average, you will pay more toward interest than principal over the first 18 years on a 30-year loan.”
But when you opt for a shorter 15-year loan, you repay your principal more quickly, including in the early years of the term. This helps you pay off your home more quickly, “which can save you a significant amount of money in total interest paid over the life of your loan,” says Dennis Shirshikov, head of growth at Awning.com and a finance and economics professor at the City University of New York.
These are among the reasons why many people choose to refinance their existing mortgage loan to a shorter 15-year fixed-rate or adjustable-rate mortgage loan.
The Pros and Cons of Refinancing to a 15-Year Mortgage Loan
Refinancing to a 15-year home loan has its advantages and disadvantages.
“A 15-year mortgage has a shorter maturity period than a 30-year mortgage,” says Katsiaryna Bardos, chair of the Finance Department at Fairfield University in Fairfield, Connecticut. “Because of the shorter maturity, the total interest paid on a 15-year mortgage is considerably smaller than on a 30-year mortgage.
This happens because interest is compounded for a much shorter 15-year period. In addition, because of the shorter maturity involved, a 15-year mortgage is viewed to have less default risk by the mortgage lender. As a result, the lender will typically charge a lower mortgage rate.”
Case in point: At the time of this writing, the average fixed interest rate for a 30-year home loan is 6.99% versus 6.40% for a 15-year fixed-interest rate loan. That difference of nearly 60 basis points, or 0.59%, can add up to substantial savings over a loan’s life.
Ponder the following scenario. Let’s say you recently purchased a home for which you borrowed $500,000 over 30 years via a fixed-rate mortgage at 6.99%. That means your monthly principal and interest payment would be around $3,323.
Over the life of the loan, you would pay approximately $696,469 in interest on top of the $500,000 principal. But if you were to refinance to a new 15-year fixed-rate loan at 6.40%, you would pay $279,069 in total interest – an astounding $417,400 less.
“Such a big difference in the interest paid over the life of the loan is due mostly to the fact that the interest is compounded for only 180 months instead of 360 months and also due to a slightly lower fixed rate,” Bardos continues.
But here’s the catch: By refinancing to a 15-year loan, your monthly payments would jump from $3,323 to $4,328 – $1,005 more a month.
“Your monthly payments will be significantly higher than if you had stuck with a 30-year loan. This may pose an issue down the line if any unexpected events impact your income,” cautions Sean Grzebin, head of Consumer Originations at Chase Home Lending. “Your higher monthly costs may not leave room for additional homeownership expenses, such as renovations or unexpected repairs and maintenance.”
In addition, refinancing involves some effort and expense. You will have to apply and get approved for a new 15-year loan and pay for closing costs.
“Refinancing costs can vary, but you can typically expect to pay between 2% and 5% of your loan amount and closing costs,” says Shirshkiov.
Using the math scenario above, if your principal balance borrowed is $500,000, that means likely forking over at least $10,000 to pay for closing expenses like lender fees, a home appraisal, title search and insurance, and a real estate attorney bill.
» MORE: See today’s refinance rates
Good Candidates for Refinancing to a 15-Year Mortgage
The best candidates for refinancing to a 15-year loan are those with sufficient income to qualify for the higher monthly payment and good credit, which means those with stable employment, higher earnings, and a healthy cushion of extra money saved just in case.
“This usually includes people who are closer to retirement and want to pay off their mortgage before they stop working,” Shirshikov continues.
Whitehead says it’s best if you have no other major consumer debts outstanding.
“If you have a credit card and pay it off in full each month, that’s fine. But if you are carrying credit card balances consistently without paying in full and also have car loans and student loans, I would recommend paying those off first before moving to a 15-year loan,” he suggests.
A Fixed-Rate vs. Adjustable-Rate 15-Year Mortgage Refi
Refinancing from a fixed-rate longer-term loan to a new 15-year adjustable-rate mortgage (ARM) can be beneficial in certain circumstances.
“It can be a good strategy, for example, if you plan to sell your house before the initial fixed-rate phase of the ARM expires – which can happen typically after year 1 or year 3 of the 15-year loan – which is when the rate becomes adjustable,” notes Shirshikov. “But this is a bit like playing the stock market because you are betting on future interest rate movements. When the 15-year loan rate adjusts, you could actually pay less or more in interest.”
But many borrowers choose a fixed-rate 15-year refinance loan because they want the peace of mind knowing that their monthly principal and interest payments will stay the same over the 15 years.
The Right Time to Refinance to a 15-Year Mortgage
The best time to ponder refinancing to a shorter 15-year term is when interest rates are lower and more favorable. After all, it doesn’t make sense to refinance if you will be paying a higher interest rate than your current rate.
“When interest rates are lower, you might be able to refinance your loan for a shorter term without seeing much of a jump in your monthly payment,” explains Grzebin.
You will also want to consider how long you’ve already paid into your existing 30-year mortgage loan, Jennifer Fernandes, supervisor of Real Estate Origination for Service Credit Union in Portsmouth, New Hampshire, points out.
“That’s because the longer you’ve been making payments, the higher the percentage that your payments are going toward the principal versus the interest,” she says. “If you’ve already reached the point of paying more principal than interest, you should consider keeping your 30-year mortgage loan.”
Whitehead only recommends going with a 15-year loan when the rest of your financial house is in order.
“In most cases, if you have consumer debt, such as credit cards, that is not paid off each month, you should pay off those debts first,” advises Whitehead. “I also recommend maxing out your retirement contributions before refinancing to a 15-year loan.”
Keep in mind that you can achieve the benefits of paying less in total interest without going through the hassle and expense of refinancing if you make accelerated mortgage payments. This involves paying extra toward your principal each month, which will shorten your amortization schedule and the life of your loan – which could save thousands in total interest paid.
“In most of my conversations with customers, I’m telling them to keep their current 30-year loan and just pay it like a 15-year loan,” Whitehead says.
But if and when interest rates drop lower than what you’re being charged for your longer-term loan, it’s smart to crunch the numbers and think seriously about a refinance if your goal is to repay your debt more quickly and reap major interest savings.
How to Refinance to a New 15-Year Mortgage Loan
The process of refinancing to a new 15-year mortgage loan is similar to what you went through to get a longer-term loan recently or years ago.
“It involves shopping around among different lenders and loan programs, applying for the new loan, undergoing a home appraisal, reviewing the loan terms, and then closing on the loan,” Shirshikov notes. “The timeline can vary, but it typically takes 30 to 45 days from application to closing date.”
Be aware that you can close more quickly if your new lender does not require an appraisal. This can be the case if you switch your mortgage to a new FHA, VA, or USDA loan via a streamline refinance.