With interest rates at historic lows, homeowners in good financial shape have a chance to refinance their mortgages and get a better deal.
The tumbling cost of home loans has sent an index that tracks refinance activity up 168% since a year ago, according to Mortgage Bankers Association data thru March 27. Three out of four (75.9%) mortgage applications in the most recent weekly MBA survey were for refinances not purchases. A mortgage refinance is when you replace your current home loan with a new one.
This type of financial maneuver occurs when homeowners are looking to take advantage of rates that are much lower than what they currently have. Potential benefits of refinancing include: saving on interest; lowering your monthly payment; or paying off your mortgage faster.
“The current rate environment may be good time to look at refinancing or consolidating all types of debt,” says Scott Solomon, a senior VP, at Ayco, a Goldman Sachs company that specializes in company-sponsored financial counseling programs.
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With the economy likely already in recession, refinancing an existing mortgage may be easier to execute than say, selling a home and moving to a new one.
While most homeowners opt for getting a new 30-year mortgage so they can lower their payments, there are some benefits of going for a shorter 15-year mortgage.
“A 15-year mortgage has lower interest rates as you are borrowing money for less time,” says Tendayi Kapfidze, chief economist at Lending Tree. “This means you will pay less interest over the life of the loan and pay down the loan faster.”
You’ll also build equity in your home more quickly.
The catch, of course, is your monthly payments will be larger.
Consider a refinance of a current median-priced home of $270,100, according to the National Association of Realtors, with a loan-to-value ratio of 80%. With a refinance amount of $216,080, you’ll pay more each month on a 15-year loan than you would a 30-year mortgage, but you’ll pay a lot less interest over the life of the loan.
Using Bankrate’s average 30-year mortgage refinance APR of 4.04% and the lower 3.47% APR for a 15-year loan, the numbers would look like this:
You’d pay $1,542 per month for principal and interest on the 15-year product, or $505 more than a conventional 30-year loan. However, the total cost of the 15-year refinance would be $277,477, or nearly $96,000 less than the 30-year mortgage.
Pros of a 15-year mortgage
Whether to go with the 15-year option has a lot to do with your goals, financial status and stage of life.
“If it fits your budget, it’s a good option,” says Kapfidze. “If you have enough income to take on the higher payment, you should consider it as you ultimately pay less interest in the long run.”
The big unknown, of course, is whether your financial circumstances will suffer a negative turn due to, say, a job loss, health emergency or big unexpected expense.
While paying off your home quicker might be a lifelong dream, you might someday regret locking yourself into a bigger monthly payment.
“A larger payment could be difficult if there is disruption to your income,” Kapfidze says. “It’s all about budgeting. So, look at your full financial profile before you decide.”
Devoting more of your monthly income to paying off your home faster means you could have less cash available for other purposes, such as investing or contributing to your child’s college tuition.
“When interest rates are at an all-time low, shortening a loan doesn’t make sense,” argues Michael Foguth, founder of Foguth Financial Group. “The equity in a home will give you nothing until you sell it. Paying it off quickly only takes away from money that could be put toward other things.”
Still, switching to a 15-year mortgage could make sense for someone nearing retirement who doesn’t like debt, Foguth says.
“Some people don’t want the burden of a mortgage over their head as they head into retirement,” Foguth says. “So, if you’re one of those people who are 15 to 20 years away from retirement and you’re already maxing out your 401(k)s and Roth IRAs, then you could look at paying off your mortgage faster.”
While there’s no denying that saving on interest and paying off your home faster with a 15-year mortgage refinance are plusses, that’s not to say it’s a risk-free decision, Foguth says.
“The major risk of a 15-year mortgage includes a higher monthly payment that will tie up more of your money into the house,” Foguth says. “Should you need or want that money in the future, you’ll have to ‘ask’ the bank for a loan and pay them the interest on your own asset.”
Another option to pay off your mortgage faster is to refinance into a 30-year fixed mortgage with lower monthly costs and make extra principal payments with the money you would’ve spent each month on the 15-year loan. That way you’re on track to pay the mortgage off earlier than 30 years but have the flexibility to not have to pay the bigger payment each month if your financial situation deteriorates.
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