Refinancing from a 30-year to a 15-year loan may seem like a no-brainer. Who wouldn’t want to pay off their loan in half the time? But it’s not an easy decision like you might think. You have many factors you must consider before making the switch.
Your Payment Will Increase
Perhaps the largest concern is how much your payment will increase. Even though you can get a lower interest rate on a 15-year loan, your principal payments will have to increase in order for you to pay your loan off in half the time.
For example, on a $150,000 loan you’d have the following payments:
- 30-year loan at 4% – $1,267
- 15-year loan at 3.5% – $2,054
This can make it harder to afford the payments. Even if you can afford the payments, think of other effects on your budget.
- Do you have other debts to pay? Will you still have the money to cover those debts?
- Do you have an emergency savings account? Will the higher payment impede your ability to save money?
- Do you invest money elsewhere? It’s a good idea to diversify your investments rather than putting all of your money into your home.
If you are up-to-date on your other debts, have an emergency savings account, and have other investments, you could be in good shape to pay off your loan with a 15-year loan.
Will You Qualify?
Just because you want a 15-year mortgage doesn’t mean that you’ll qualify. You have to be able to prove that you can afford the higher payments. Each loan program has their own debt ratio requirements that you must meet:
- Conventional loans – 28% housing ratio and 36% total debt ratio
- FHA loans – 31% housing ratio and 41% total debt ratio
- VA loans – 43% total debt ratio
If you don’t have many other debts and your income is high enough to cover the higher 15-year payment, you may be in good shape to refinance into that 15-year term.
Will You Save Enough?
Just because you can pay the loan off in half the time, doesn’t mean the 15-year loan always makes sense. It really depends on the interest rate you can get or in other words, the interest savings you’ll earn.
Lenders don’t have to give you the lowest rate available at the time just because you opt for a 15-year term. It depends on your qualifying factors. If you are a high risk of default, the lender can still give you an inflated interest rate.
The best way to tell if it’s worth it is to look not only at the monthly interest savings, but also the lifetime interest savings. Then consider what you’ll do with the savings. Will you invest it elsewhere? If so, this could be a good choice. If you won’t, but will instead just increase your spending, it may make more sense to keep the 30-year term. This is also the better choice if the savings isn’t that great. Why put yourself at risk of mortgage default when you aren’t going to save that much money?
Alternatives to Refinancing Into a 15-Year Term
Did you know that you don’t necessarily have to refinance into a 15-year term to make 15-year payments? Most loans today don’t have a prepayment penalty. This means you can pay extra principal when you can.
You can use any of the following tactics to help you pay your 30-year loan off in less than 30 years:
- Make 15-year payments on your own – Using a mortgage calculator you can figure out how much principal you must pay each month to pay off your loan in 15 years or any increment less than 30 years. You can then make those extra principal payments each month. This way you avoid the cost of refinancing.
- Pay a little extra principal each month – If you aren’t able to afford the 15-year payment, but can pay a little extra towards your principal, go for it. Even just $100 a month towards principal can knock your balance down and shave a few years off your loan.
- Make an extra mortgage payment each year – Making just one extra mortgage payment can knock years off your loan’s term. You can make the payment in one lump sum or divide the payment up into 12 payments, adding it to your regular mortgage payment each month.
Keep in mind that if you decide to refinance, you need to watch the closing costs. If they are too high, it can deplete the benefit of refinancing into a 15-year loan. Go over your options with several lenders to see who has the best deal for you. If you aren’t comfortable making the switch, just make the payments on your own and enjoy owning your home free and clear sooner.