Refi to a 15-Year Mortgage or Make Extra Payments?
You want to pay off your home sooner. A popular way to do this is to refinance into a 15-year mortgage.
It forces you to pay off the loan faster.
But what if that’s not the best way to pay off a house? Surprisingly, making extra payments might work out better.
Check today's 15-year refinance rates.
Making Extra Payments vs. a 15-Year Refinance
Every person’s scenario will be different, but we’ll make the following assumptions.
You are three years into your 30-year mortgage
Your original loan balance was $300,000
Your current interest rate is 4%
You can refinance into a 5% 15-year mortgage
You will incur $5,000 in closing costs to refinance
New 15-Year Mortgage | Keep 30-Year, Make 15-Year Payment | |
Closing Costs | $5,000 | $0 |
Loan Balance | $288,500 | $283,500 |
Payment | $2,281 | $2,281 |
Years Remaining | 15 | 13.5 |
Total Interest Paid | $122,000 | $83,000 |
In this example, you pay off the loan more than a year earlier and save $44,000 in closing costs and interest charges by keeping your 30-year loan. Simply make a payment as if you had the 15-year.
This strategy saves you from paying closing costs. You also don’t give up your low interest rate if it’s not available anymore.
15-Year Mortgage Drawbacks
A 15-year mortgage sounds like a great idea on the surface. But they can be dangerous. How so?
You are forced to make a higher payment each month. If you can’t make the full payment, your credit takes a hit and you may even lose the home.
With a 30-year loan, you have the option to make extra payments without a penalty. But you don’t have to.
The lower payment gives you some cushion as property taxes and homeowner’s insurance rates skyrocket across the country.
A 30-year mortgage also offers more flexibility if your spouse wants to stay home with the kids or you want to start a business.
A 15-year loan might force you to stay in a job you don’t like or eliminate the opportunity to accomplish other goals.
Having a 15-Year Mortgage Requires A Larger Emergency Fund
Experts recommend you have 6 months of expenses in savings for emergencies.
Having a $3,000-per-month 15-year mortgage payment, you need $18,000 in emergency savings not including other expenses.
A 30-year payment of $2,000 would reduce recommended emergency savings by $6,000.
Having a 15-Year Loan (Or Making Extra Payments) Comes With Opportunity Cost
Paying off a home faster may not benefit you.
It comes with an opportunity cost. You are not able to invest as much into retirement accounts, buying other real estate, or other investments.
If you pay a 5% interest rate on your 15-year mortgage, you essentially make a 5% guaranteed return by paying down the loan. Not bad.
But some investments can yield a return of 7-10% with little risk. Over 15 years, saving $1,000 per month at a 7% return instead of putting that toward your mortgage gets you a final balance of $301,000 says investor.gov. This could be a better outcome than having a free-and-clear home, depending on your goals.
Should You Ever Refinance Into a 15-Year Loan?
There are a few instances when getting a 15-year loan makes sense.
Forced Savings
The most useful attribute of a 15-year mortgage is that it forces you to pay down your mortgage.
Those who have a hard time voluntarily investing or paying down debt might find a 15-year mortgage very useful. It’s an amazing forced savings vehicle.
Large Rate Reduction
Another use case is if you can drastically reduce your mortgage rate. For instance, going from 30-year loan at 7.5% to 15 years at 4% on a $300,000 loan only increases your payment by about $100 per month.
The Payment Is Still Affordable
Someone with a high income that is nearly guaranteed to continue doesn't take on much additional risk by refinancing into a 15-year loan.
Should You Refinance?
A 15-year loan can be a fast track to owning a home free and clear. But for most people, simply making extra payments as if they had a 15-year loan could pencil out better.
Speak to a licensed loan officer here to discuss your options.
