Thinking about switching up your mortgage structure to save money? Today’s lower rates could mean now is a great time to refinance your mortgage, and shave off extra time and interest if you refinance into a shorter loan term.
In case you haven’t been keeping up with the latest mortgage interest news, rates on home loans have dropped pretty significantly lately. In fact, the Mortgage Bankers Association (MBA) recently reported the average contract interest rate for 30-year fixed rate mortgages with conforming loan balances ($484,350) or less decreased to 3.90 precent from 3.93 percent.
For 15-year fixed rate mortgages, the average contract rate was even lower at 3.30 percent.
Benefits of Shorter Term Mortgages
Shorter term home loans typically have lower interest rates because they are less risky to lenders. Where a 30 year home loan will take a lot longer for the borrower to repay, a 15 year loan could get paid off in half the time, meaning the lender will get their money back a lot sooner. Likewise, borrowers can benefits from choosing a shorter term loan because it gives them the ability to pay off the loan sooner and pay less interest over all.
How it Works
A shorter term mortgage means you’ll be making payments over a shorter time period, therefore, your payments will be higher but the tradeoff is that you will save a lot of money over the long term. Let’s use an example to illustrate:
Let’s say you’re buying a $300,000 home. You make a down payment of 20 percent ($60,000) which means you need to borrow $240,000. Your mortgage lender charges you an interest rate of 3.90 percent for a 30-year fixed rate loan. This makes your monthly payment around $1,132 (not including any property taxes, homeowners insurance, HOA fees, etc.)
With this scenario, assuming you kept the mortgage going for the full 30 years, you would wind up paying about $167,522 in interest alone, not to mention it would take 30 years to be mortgage-free!
Now let’s look at what a scenario would look like with a 15-year fixed rate mortgage instead:
Let’s say you’re buying the same house–$300,000 with a 20 percent down payment. You need a loan for $240,000. Only this time, you choose a 15-year fixed rate mortgage. Your lender charges you a much lower interest rate; only 3.30 percent. This makes your monthly principal and interest payment (before taxes, insurance, etc.) around $1,692. While this is certainly higher than the payment you’d have if you chose a 30-year loan, more of your payment would go towards repaying the principal each month and therefore you would end up paying off the loan sooner, plus paying significantly less in interest over the course of the loan.
With the above example, if you chose the 15-year option at a 3.30 percent interest rate, you would pay around $64,604 in total interest. That’s $102,918 less than what you’d pay if you chose the 30-year mortgage!
Refis on the Rise
Refinancing activity has been on the rise lately, thanks to lower rates. According to the MBA, the refinance share of mortgage activity for the week ending August 16 increased to 62.7 percent of total applications from 61.4 percent the week before. The fact that refinance loans accounts for well over half of all mortgage activity lately says volumes. Homeowners are seeing the benefit of staying in their homes and refinancing to save money. But refinancing to a shorter term mortgage may not be the best solution for everyone.
Refinancing to a 15-Year Loan
If you’ve already purchased a home with a 30-year mortgage and are interested in refinancing to today’s lower rates, a 15-year mortgage could help you save even more over time. However, you should decide if making the higher monthly payments is really worth the longterm savings.
If you don’t think you’ll own the home for more than a few years, it may not be worth paying more money each month. On the other hand, the more equity you can build in your home, the easier it could be to sell it for a profit or refinance it again down the road. It all depends on your financial comfort level and homeownership goals.
Talk to a qualified loan professional or financial advisor for details and to see if a shorter term home loan makes sense for your situation.