Refinance a 30-Year Mortgage to a 15-Year: How to Decide

refinance mortgageWhen deciding to refinance a 30-year mortgage to a 15-year, know that it could build up equity faster and save money over the life of the loan.

By: Ilyce Glink and Samuel Tamkin

Q: I recently talked to Chase and Quicken Loans and Quicken came back and said I could lower my monthly payment by $100 and go from a 5.75 to a 4.5% interest rate. The payment is only $100 cheaper a month because the insurance rate has gone up $100 a month. The closing costs for Quicken will be about $550. How do I know it’s worth taking the deal? We don’t plan on being in the same condo for more than a couple more years. Thanks!

A: If you save $1200/year and it costs you $550, then you’re saving money starting at the 6 month mark. If you stay 2 years, you save about $2,000. And so on. If you are refinancing your current loan balance, that’s pretty good. Can you go lower if you go to a 15-year loan? That might be better for you.

Q: Thanks for the advice! I’ll ask about the 15-year loan. Wouldn’t the monthly payments double if you go from a 30 to a 15? Also, I heard that it’s more attractive to a buyer if the current rate is low with an FHA loan because the new buyer can take keep the same loan. Would it be worth it just for that? Going from a 5.75 to a 4.5?

Finally, should I shop around more and call a credit union and any other lenders? Or are they all going to be about the same? I figured Quicken Loans is a pretty reputable company and they seemed to really want to help.

Also, I love the Sunday afternoon show on WGN Radio. Great stuff!

A: You’ve asked a couple of good questions. Let’s start with the idea that your payments will double if you go from a 30-year mortgage to a 15-year loan.

While you are cutting the term of the loan in half, you don’t exactly double your payments. Some of that has to do with the way the money compounds and some of it has to do with the idea that when you have a shorter-term loan, you’ll pay less in interest.

In your case, If you’re being quoted 4.5 percent on a 30-year rate, the 15-year mortgage rate might be 3.5 percent. (As we were hunting around online, we saw less expensive rates available, so you might want to shop around a bit more, or make sure you know where your credit score is, because that could be causing lenders to quote you a slightly higher interest rate.)

Let’s assume you have a $200,000 mortgage. If you chose a 30-year loan at 4.5 percent, your monthly payment would be $1,013.37. Over the life of the loan, you’d pay $364,814, of which $164,814 is interest.

Now, let’s compare a loan for the same amount, but a 15-year term. The interest rate would be 3.5 percent, and your monthly payment would be $1,429,77, or roughly $417 more than your 30-year payment. But look at the loan term total numbers: You’d pay just $257,357 over the life of the loan, and only $57,357 in interest. You’d build up a ton of equity much faster and save more than $100,000 over the life of the loan.

Ilyce has four rules that she says make up what she calls a “home run refinance.” First, you want to lower the interest rate, which you’re doing. Next, you want to lower your monthly payments (though this isn’t always possible). Third, you want to shorten the loan term. And, fourth, you want to manage your closing costs. If you can manage to wrap each of these things into one refinance, it’s a no-brainer “home run” refinance.

But there are times when you might choose a longer loan term and lower payment simply because you can’t commit to the shorter term and higher payment schedule. And that might be a good idea if you’ve lost your job recently or feel insecure about having cash come in.

The truth is that interest rates are still at or near historic lows and if you know you’re going to stay in your home for a decent amount of time, you should try to refinance for the shortest loan term because that’s how you’re going to save the most money.

FHA loans are assumable, meaning that if someone can qualify for the mortgage, they can take over the payments. That sounds amazing, but the deal a little harder to put together than you imagine, because few first-time buyers (who typically are those looking at FHA loans), actually have enough cash on hand to pay you the equity you’ve built up in the property.

Let’s say you have a property worth $220,000 and you refinance for a $200,000 loan for 15-years. After 7 years, your principal balance will be about $119,000. Even if the property isn’t worth any more than it was when you refinanced, it would still be $220,000. The buyer would need to come up with about $101,000 in cash in order to take over the remaining balance of the loan. There are very few first-time buyers who can do that, or even trade-up buyers. It’s just hard to come up with that cash. And, more likely than not, the property will have gone up a little in value, which means the prospective buyer has to come to the table with even more cash on hand.

The whole scenario seems quite unlikely. So it doesn’t pay to refinance with FHA just so that some future buyer can assume your loan. Our guess is that this won’t happen so you should choose the loan and refinance terms that make the most sense for your life.

Finally, let’s address the idea of shopping around. We don’t ever believe you should only shop with one lender. If you don’t go out and talk to four or five different lenders, even if they’re reputable, you won’t know if you’re getting a great deal of getting ripped off. So, talk to a credit union, local bank or savings and loan, a national lender and a reputable mortgage broker. See what deals you’re being offered for a 15-year and 30-year fixed rate loan. Get all of the costs together and create a spreadsheet so you really understand what you’re paying and what you’re being offered. Then, you can make an intelligent decision about which lender should get your business.

Thanks for listening to Ilyce’s show. Best of luck.


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About Ilyce Glink

Author of 13 books, including the bestselling 100 Questions Every First-Time Home Buyer Should Ask. Writer of the nationally syndicated column, “Real Estate Matters.” Top-rated radio host in Atlanta. Writer for CBS MoneyWatch.com. Managing editor of the Equifax Personal Finance Blog.
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