Refinancing Into a 15-Year Fixed Mortgage - Pros and Cons

By Brandon Cornett
© 2011 All rights reserved

Many homeowners choose to refinance their homes using the 15-year fixed-rate mortgage. Refinancing into this type of loan has certain pros and cons, and they can be summed up in a single sentence. You'll have a larger mortgage payment than if you'd refinanced into a 30-year loan, but you could save a ton of money in interest costs.

In a nutshell: The shorter term means that more of your payment goes toward the principal. Over the life of the new loan, this could reduce your total interests costs by tens of thousands, or even hundreds of thousands of dollars. You might even be able to do this without increasing the monthly payment you have right now. Now you can see the appeal of the 15-year mortgage refinance strategy.

That was the short answer. Here's the long one:

15-Year Mortgage = Less Total Interest

If you choose a 15-year loan over the 30-year option, the mortgage will amortize over a shorter period of time. This will greatly reduce the amount of interest you pay on the loan. Remember, you are paying interest on every one of your monthly payments. So when you spread those payments out over a longer period of time, you end up paying more money in total interest costs.

The table below shows the difference in cost between a 15-year and 30-year mortgage loan. Let's say you were to refinance your home with a new mortgage amount of $250,000. A 15-year fixed-rate mortgage will generally have a lower interest rate than its 30-year counterpart. The size of the difference varies, but it's usually half a percentage point or more. In the example below, I used the average rates reported by Freddie Mac at the time this article was published (March 2011).

	15-year loan	30-year loan
Loan Amount	$250,000	$250,000
Interest Rate	4.15%	4.88%
Monthly Payment	$1,868	$1,323
Total Interest Expense	$86,252	$226,560

In the example above, you'll notice the 15-year fixed mortgage has a lower interest rate than the 30-year loan. This is typical. But the monthly payment is still higher on the 15-year loan, because you are essentially cutting the payback period in half. If you recall from the beginning of this article, I mentioned that this was the primary disadvantage of refinancing into a 15-year mortgage. You will have a larger monthly payment than you would if you used a 30-year loan.

But you will only be paying interest for 15 years versus 30 years, so the total amount of interest will be significantly lower on the 15-year fixed mortgage. As you can see in the example above, there's a huge difference in the amount of interest paid over the terms of these two loans. By using the shorter term, you could save more than $140,000 when compared to the longer term.

But Can You Afford the Larger Payment?

This is the first question you need to ask yourself before refinancing into a 15-year mortgage. Can you afford the larger payment that will result from the shorter-term? This brings up the topic of priorities. What is your number-one priority for refinancing your home? People refinance for different reasons, after all. Are you trying to lower your payments, or pay the loan off sooner? Are you primarily concerned with the amount of interest you'll pay over the term of the loan?

• If you want to minimize your monthly payments, you should consider refinancing into a 30-year fixed-rate mortgage. You'll pay a higher interest rate, but you will also spread your payments out over a longer term. Refer back to the example above to see how this results in a lower payment (even with the higher rate).
• On the contrary, if you can afford the higher payment but want to pay your loan off sooner, you should probably opt for the 15-year mortgage. This will also greatly reduce the amount of interest you pay over the life of the new loan.

Will You Stay Long Enough To Benefit?

You also need to consider your long-term plans before you rush into this decision. Are you going to stay in the house (and keep the new loan) for many years? If so, you can justify paying the closing costs. But if you plan to sell the home in a few years, it probably doesn't make sense to refinance it now.

Melissa Cohn, president of the Manhattan Mortgage Company, describes the ideal candidate for a shorter-term: "It's people who are established in their residences and are not going to be moving and are comfortable in their income stream."

You will probably pay thousands of dollars in closing costs when refinancing. So you have to make sure that the savings (from a lower payment or reduced total interest) is greater than the amount you pay in closing costs. This is known as the break-even point, and you can learn more about it in this article.

Do You Have Enough Equity to Refinance?

Pop quiz. How much equity do you have in your home right now? If you don't know the answer, you've got some homework to do. In order to refinance into a 15-year mortgage, you will need a certain amount of equity in the house.

Equity is the difference between the current market value of your home and the amount you owe on your mortgage. If my house is worth $250,000 in the current market, and I have a mortgage balance of $150,000, then I have $100,000 worth of equity. This comes out to about 40% of the market value, so I have 40% equity (or ownership) in my home. A homeowner in this situation should have no trouble getting approved for a refinance loan.

But if you have a small amount of equity -- or worse, negative equity -- you will have a harder time getting approved for the new loan.

How much equity do you need to refinance your mortgage? This will vary based on the lender you use and the refinancing strategy you're pursuing. If you are doing a straight refinance without taking any money out, the lender might require 10% equity or more.

These days, in 2011 and beyond, some lenders are requiring as much as 20% equity for refinance loans. If you're doing a cash-out refinance, you will probably need 20% equity or more. Again, the requirements will vary from one lender to the next. So don't take these numbers as gospel. The only way to find out for sure is to ask the lender.

Home Appraiser, Incoming

When you call up the lender and say you want to refinance into a 15-year fixed-rate mortgage loan, one of the first things they will do is measure your equity. They might do an informal check at first, by using online data. But eventually, they will send a certified home appraiser out to your house.

The appraiser will determine the current market value of your home, based on recent sales data in your area. He will also consider any upgrades or unique features you have -- a swimming pool, a large corner lot, an upgraded kitchen, or anything else that adds value.

Based on this research, the appraiser will tell the lender how much he feels the home is worth. The lender will compare this number to the amount you currently owe on your mortgage, in order to determine your equity.

If your equity is too low, the lender will probably turn you down for the loan. If your equity meets their guidelines, they will move on to other checkpoints in the mortgage approval process. They'll check your credit score, your income and debts, etc. But it usually starts with the amount of equity you have. This factor alone can make or break your chances of getting a refinance loan.

So you might want to spring for a home appraisal of your own, before you start talking lenders. Or you can just apply for refinancing and let the lender send the appraiser out. Either way, you will find out how much equity you have and what you're refinancing options might be.

Summary of Key Points

Let's sum up the key points we discussed in this article. Refinancing into a 15-year fixed mortgage has certain benefits and advantages. You will have a larger monthly payment than you would if you chose a 30-year loan. But you could also save a lot of money in interest costs, especially if you remain in the house for the full 15-year term. This is the number-one reason people choose a 15-year loan over a 30-year term when refinancing.

So it really comes down to your priorities. Are you trying to minimize your monthly payments, or reduce the amount of interest paid over the term of the new loan? Will you be staying in the home long enough to justify the closing costs for the new loan? How much equity do you have in your house right now? These are all questions you need to answer before making a final decision.

This article explains the pros and cons of refinancing into a 15-year loan. If you would like to learn more about this topic, you can use the search tool located at the top of this website. You'll also find some helpful articles in the refinance section of our website.