In the decade-long run-up to the bursting of the housing market bubble, millions of Americans got caught up in playing a game of home loan limbo: how low can my payments go? And with every cha-ching of the refinance ATM, the recipe of lower payments and more cash-out led to one result: an extended mortgage payoff date. For some, this just meant they would pay on a 30-year loan for a year, then refinance it every year, hitting the snooze button on that 30-year clock and never getting any closer to paying their mortgage off. Other homeowners, however, went from 30-year mortgages to 40-year mortgages, getting a lower payment -- despite increasing the loan's balance -- just by virtue of spreading that payment out over more years. The prevailing sentiment was that most people would never pay their mortgages off anyway, so why try?
Why indeed. Fast-forward to today, after the bubble. Conspicuous Consumption is OUT. Conspicuous Frugality is IN. Americans everywhere are trying to save as much as they can, anywhere they can. And with interest rates at historically low levels, many savvy homeowners are refinancing into today's low rates, not to extend their loans or get cash out, but to get shorter loan terms!
In 2007, only 1 in 10 refinancing homeowners chose a 15-year fixed-rate loan; so far in 2010, 1 in 4 refi-ed into a 15-year fixed, vs. a 30-year loan, according to mortgage data company Corelogic.
Refinancing into a shorter loan is not just about paying your mortgage off faster. Banks price mortgages based on how risky they are; the longer the loan, the higher the risk of default. The shorter the loan term, the lower the interest rate is. If you thought that this week's 4.32% interest rate on a 30-year-fixed rate mortgage was low, get this: the interest rate on a 15-year-fixed rate loan is an unbelievable 3.75%!
So, while refinancing from a 30-year to a 15-year home loan will virtually always drive a homeowner's monthly mortgage payment up, right now, that increase is mitigated by having an interest rate several points lower than the 6%- and 7%- rate loans many of these homeowners had from 2004 and 2005.
Admittedly, many of those refinancing from 30-year loans into 15-year mortgages are homeowners who have some equity left and have a payment they can manage in the first place, because those who are upside down (i.e., owe more than your home is worth) or behind the mortgage payment 8-ball (i.e., behind on their monthly payments) are not usually in a position to refinance.
As well, people who are living a little more paycheck-to-paycheck or don't feel a high level of job security may not want to make the commitment to the higher monthly payment of a 15-year mortgage; if this describes your situation, you might want to consider simply making an extra payment every year or following one of the many early payoff strategies where you simply apply extra cash to your principal when you can, versus locking in a higher payment to get the lower, 15-year rate.
If you do have the cushion, though, and you are considering refinancing your 30-year-loan into a 15-year mortgage, here are three reasons it may make sense to do so:
1. Pay your home off faster. To paraphrase Gordon Gekko, SPEED is good. Especially when it comes to paying your house off. As much heat as home ownership takes, the fact is, if you are ever in a position to pay off your mortgage, you nearly eliminate housing expenses, something that never happens when you rent. By definition, a 15-year mortgage positions you to own your home free and clear in half the time (of course, taxes and insurance don't go away). Just in time, actually, for many homeowners to pay for college tuition!
2. Free yourself from the market cycles. On a 30-year mortgage, nearly the first half of the loan is amortized in a way that you're primarily paying interest, so very little equity is being built up. As a result, many 30-year mortgage borrowers look to market appreciation for the only increase in equity they can count on during the first half of the life of their loan. And we all know that market appreciation simply isn't something we can rely on, especially these days.
With a 15-year loan, you pay your principal off more quickly. As a result, you build equity up consistently and without relying on the market to increase the value of your home.
3. Save tens, even hundreds of thousands of dollars.According to the National Association of Realtors, the median sales price for all existing American homes in August 2010 was $178,600. Finance that for 30 years at 4.375%, and you'll pay $140,338 in interest over the 30 years. Elect for a 15-year mortgage at 3.75% instead? You'll pay only $55,187 in interest over the life of the loan -- 60% less interest, a savings of over $85,000!
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