My husband and I took out a 30 year mortgage when we bought our home. Our wages/income has gone up in the 5 years since we bought the house. Should we take out a 15 year loan to reduce our total interest costs since we can now afford a larger monthly payment?
Letitia - What a great question. The answer depends upon two distinct but related factors: (1) 15 year mortgage rates are typically less than 30 year mortgage rates, due to the faster amortization schedule and the fact that the interest rate yield curve is generally upwardly sloping (longer term financing rates are usually higher than shorter term rates); and (2) You mention that you purchased your home 5 years ago, but did not say whether you had refinanced in the meantime. You probably know that long-term mortgage rates have plummeted since you purchased your home, so unless your loan is floating or you refinanced sometime during the past year, any new loan is likely to offer a lower rate than what you currently have.
So how should you think about this question? First, compare the annual percentage rate (APR) on the 15 year rate vs. your current loan. If it is the same or higher, you should keep your existing loan. If you have excess cash flow, consider making a principal reduction payment to reduce the amount of the loan. Your payments may not change, but you should be able to reduce the total interest owed to the lender. If the 15 year rate is lower than the rate on your current loan, it may make sense to refinance if the rate differential justifies the time and hassle. My personal rule of thumb is that the rate improvement should be at least .50% before refinancing makes sense. Other people might have higher or lower thresholds; it's really a personal decision. One important point: make sure your rate is fully-loaded, meaning that it should include closing costs, appraisal fees, origination charges, or other expenses that would affect your loan proceeds or your periodic payment schedule. Sometimes these fees and expenses are broken out from the loan interest rate, which can be deceptive. Ask your broker or lender to calculate an all-in rate, including all fees and charges. Or check with a financial advisor if you don't think you are getting a clear explanation.
Another issue to consider, even if the rate is substantially lower with a 15 year loan: do you have sufficient cash flow to cover the monthly payment if your income is adversely impacted? What would happen if you or your spouse became unemployed for a period of time, or became ill, or had to take a lower paying job for some reason? Remember that the cost of financing is not the only factor you should consider; cashflow may also be important. There may be an easy way to provide for this contingency. For example, you might be able to secure a home equity line of credit (HELOC) to provide an emergency buffer. Or you might already have an emergency reserve. Just keep in mind that if you shorten the duration of your mortgage and accelerate the amortization schedule, you will be cutting into your cashflow margin of safety.
I hope this helps you think about your decision. Best regards.
My wife and I faced this same decision when we refinanced our mortgage a few months ago. What we ultimately decided to do was refinance to another 30 year fixed mortgage even though we could have afforded the 15 year loan and saved a bunch of interest over the life of the loan. We ultimately made this decision on the basis that the 30 year mortgage gives us more flexibility. Instead of the 15 year loan, we refinanced to a 30 year note but are paying an additional $1,000 per month against the principal. In this scenario, we'll pay off the loan in a little less than 15 years, but if circumstances arise where we need to redirect some of our monthly cashflow, I have the flexibility to do this without having to refinance our loan. Basically, I'm getting the benefits of a 15 year loan based on our accelerated payments, but I have the flexibility of the lower payment associated with the 30 year loan. I've recommended this approach to some of my clients in the past, and they've all appreciated the flexibility and additional control it gives them. There are certainly other considerations, but this is what made the most sense for my personal situation. Hope that helps.
Another strategy would be to stay with your current 30 year loan and invest the difference between the two payments in a mixture of stocks, bonds, CD's etc. If the difference was $500 per month and you invested that amount for 15 years at a 6% return the money would be worth $145,000. Now amortize your current 30 year loan and see what you will owe the mortgage company 15 years from now. If that amount, in our example were, $100,000 you have the option of paying it off with your savings and have some money left over. You would also receive more tax deductions for the 30 year loan too, if the amount owed, on your current mortgage, after 15 years is $250,000 it may be better to taking the 15 year loan. Of course this strategy calls for a person to be very disciplined, if you don't feel you can consistently save the money it may not be for you.
Jeff- by your logic shouldn't everyone borrow against their home and invest it in the market? Any portion of the investment that is allocated to bonds or CD's would be burning money--- bond yields and CD rates are below mortgage rates and taxable---so really what you are suggesting is borrowing to buy stocks, which may not be prudent regardless of how disciplined their approach.
I agree with Russ: Borrow long but pay short. You won't get the lowest interest rate, but you will gain flexibility in what you are required to pay on a monthly basis. You can then hopefully prepay some principal each month, effectively reducing the term of your mortgage. Good luck!
My wife and I had a similar decision to make while we were paying off our mortgage. We were being hyperaggressive in paying that thing off (kill your mortgage as quickly as possible; your blood pressure will thank you!), but we had a pretty crummy 2006 vintage rate, so it was very lucrative, potentially, to refinance to a 15 year (or even a 10 year) note to get a lower interest rate. We didn't. Here's why.
We had to pay closing costs and loan origination fees. Since we were going to be paying off our mortgage in under two years, we were not going to be able to recoup the fees as a result of the lower interest rate. So, if you're going to be a) aggressively killing your mortgage, or b) potentially moving in a couple of years, you'll want to incorporate the fees and closing costs into the new mortgage payment to make sure that the breakeven point (the point at which you've saved more from the interest payments than you paid in those costs) is shorter than the amount of time that you'll either own the home or have a mortgage.
When that mortgage is gone, you'll feel a state of euphoria the first couple of months when you can say "hahah! I don't have to pay that $$#& bank anymore!" Then, amazingly enough, the feeling wears off (hedonic adaptation in reverse?), and soon, it evolves into another feeling, which is neat too - "How did we ever live with a mortgage?" Can't wait until you get there!
