From most lenders today, there is a full point difference in mortgage interest rates between a 30 year and 15 year mortgage. As of this writing, U.S. Bank is charging 4.5 percent on its 30-year fixed, while the 15 year mortgage is 3.5 percent. With a difference of 100 basis points between the two rates, does it make sense to refinance a 15 year mortgage?
Is the 15-year mortgage right for you?
Let’s look at how the numbers break down: If you finance $300,000 at 4.5 percent on a 30 year fixed loan, you’ll be making 360 payments of $1520.06 a month. Because of the amount financed and the term, your first payment will be overwhelmingly interest, $1125.06. That first payment only pays down $395.06 in principal, maybe enough for you to outright own the bedroom ceiling fan.
By the last payment the balance between principal and interest will be reversed. $1,514.38 will pay off the last of the principal with only $5.68 going to interest. Here’s the point to keep in mind: Over the life of the loan, you will have paid $247,220.13 in interest to borrow $300,000.
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Financing the same amount with a 15 year fixed rate mortgage at 3.5 percent, the difference is substantial. During the 15-year life of the home loan you’ll only pay $86,036.57 in interest saving $161,183.56! It’s not just that the interest rate is lower, you’re tackling far more principal with each of your payments; $1,269.65 with that very first payment, rising to $2,138.41 with your last one.
The big issue to keep in mind is that with a 15 year loan, the monthly payment on that $300.000 rises to $2,144.65, a difference of $624.59 out of pocket every one of 180 months.
New rules effective this month from the Consumer Financial Protection Bureau require that anybody who gets a qualifying mortgage cannot exceed a debt to income ratio of 43 percent, which is your total amount of what you pay for your debts divided by your monthly gross income. That extra payment could just push you past the limit, making it impossible for the loan to be backed by Fanny Mae or Freddy Mac.
If you’ve had a 30 year loan for several years now, you wouldn’t save as much by refinancing to a 15 year loan because you’ve already started paying more of the principal. At 14 years and 9 months into the 30 year loan used as an example, you’d start to pay off more of your principal than interest every month. If you plan to move before the 15 year time frame of the new mortgage, it might not be worth the additional cost of refinancing.
Another potential problem lies in prepayment penalties. Do they exist on your current mortgage? Analyze what they are and add those to your other costs.
What will refinancing cost?
Expect to spend at least 2.5 percent of your new loan in closing costs to process it. The fees will typically include:
- A fee for checking your credit
- A for processing your loan paperwork
- Fees for lawyers
- Fees for any inspection the lender requires including for pests and the home’s structural integrity
- Discount points, equal to one percent of your home loan which will give you a lower mortgage rate
- An appraisal fee to make sure your new mortgage has an appropriate loan to value (LTV)
- A fee for a surveyor to verify property lines
- Title search fees to check to see there are no unpaid mortgages or tax liens
- Title insurance to protect the lender in case the title isn’t clean
You might hear the phrase “no-cost refinancing.” Look into specifics. It’s not that the steps listed here suddenly become free, it’s that they get added to the principal and become part of the loan.
Do the math. If you can afford the up front costs and the higher monthly payments, refinancing your mortgage with a 15 year home loan could make a lot of sense.
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