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Decision Time

Refinancing? Should You Move to a 15-Year Mortgage?

Record low rates luring many to choose shorter loan

                     Related
                     • Mortgage Payoff Calculator
                     • Mortgage Refinance Calculator
                     • Should you pay off your mortgage?

house with couple

— Samuel Hicks/Gallery Stock

Advantages of a 15-year mortgage

A lower interest rate. While almost all mortgage interest rates are low right now, interest rates on 15-year loans are even lower. In mid-June, the average rate on a 15-year fixed-rate mortgage was 4.16 percent, compared with 4.80 percent for a 30-year mortgage, reports Bankrate.com. The difference between the rates is significant, says Ethan Ewing, president of Bills.com, a consumer finance website.

But in calculating what you’d save, keep in mind that lower interest rates may mean you get less of a tax deduction on April 15. Your real savings are your lower interest payments minus higher taxes.

Lower total costs. The total amount of interest a homeowner pays over the life of a 15-year mortgage is, of course, much less than the total amount paid over a longer mortgage.

For instance, a homeowner can expect to pay a total of about $187,000 in interest on a $200,000, 30-year mortgage with an interest rate of 5 percent. Change the term to 15 years, and total interest charges drop to about $85,000, also according to Bankrate.com.

Peace of mind. Paying off a mortgage more quickly also offers a less quantitative, yet still important benefit, particularly for fifty- and sixtysomethings. “For some people, there’s a considerable psychological benefit to having a mortgage paid off when they retire,” says Michael Fratantoni, vice president of research and economics with the Mortgage Bankers Association.

Disadvantages

On the other hand, many homeowners shy away from 15-year mortgages. Here’s why:

Other debt. It makes sense to attack any credit card debt before shortening your mortgage, says Jason Lilly, director of portfolio management with Rockland Trust in Osterville, Mass. “After all, the interest rate for credit card debt is three to five times higher.”

The cost to refinance. Every refinancing transaction comes with costs, like appraisal and document preparation fees. To make refinancing worthwhile, the new interest rate should be at least 0.5 percent lower than the current rate, says Ewing. So, if you’re paying 5 percent, you’ll generally want to consider refinancing if the new rate is 4.5 percent or lower.

Also, you need to be fairly confident that you’ll be in your house for long enough after you refinance that you’ll recoup the costs. Say, if you save $200 a month by refinancing and have closing costs of $5,000, you’d want to stay at least two years.

Steeper monthly payments. In the example of a $200,000 house, the monthly payments on the 15-year mortgage come to $1,582—about $500 more than with a 30-year loan. People looking into a 15-year mortgage will want to make sure that their total debt-to-income ratio remains below 45 percent, Ewing notes. “That gives some wiggle room in case you lose income or your other expenses go up.”

However, if a homeowner already has been making payments for some time on a 30-year loan, the jump in the monthly payment isn’t quite as dramatic.

Again, take a 30-year loan of $200,000, and assume the homeowner has been paying on it for 10 years, leaving a balance of about $163,000. Refinancing to a 15-year mortgage bumps the payments to about $1,281, or a difference of $200. What’s more, that is assuming the homeowner’s interest rate stays at 5 percent; if it drops because the loan is for 15 years, the monthly payments will as well.

Karen Kroll is a Minneapolis-based finance writer and blogger. Her stories have appeared in Bankrate.com, CFO, CreditCards.com and other publications.

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