Mortgage refinance: When is a 15 year loan the right choice?

Posted by  on Nov 11, 2010

Dear Lorraine,

You are right; you can save a lot of money by refinancing to a 15-year home loan, and yes, the payment is generally higher. Here's what you need to ask yourself before deciding to refinance:

1. How long do I plan to keep my home?

This is important for several reasons. Refinancing involves fees, so you want to know that you will remain in your home long enough to recoup the cost of whatever mortgage refinance program you select. If you anticipate selling fairly soon, or have absolutely no idea how long you intend to stay in your home, you might still refinance, but you'd want a no-cost or very low-cost refinance instead of choosing the best mortgage rate and paying points to get it. In addition, a fifteen-year mortgage only makes sense for those who plan to remain in their homes for some time. Otherwise, there are shorter term programs with lower interest rates. For example, a 5-1 hybrid adjustable rate mortgage (ARM) offers a rate that runs about half a point lower than a 15-year refinance, and your rate is fixed for five years, and you can make extra payments to accelerate your mortgage payoff.

2. How healthy are my finances?

Because a 15-year mortgage requires a higher payment, it's crucial that you are confident you can meet all of your needs while increasing your housing expense. Once you put extra money toward accumulating home equity, it can be very difficult to get it back should the need arise. So I would not recommend taking on a 15-year home loan unless you are very secure in your job, have emergency savings to cover several months of living expenses, have a good health insurance plan, and have fully-funded your retirement account(s) and paid off any high-interest consumer debt.

3. Do I qualify at the higher payment?

Unless you have had your current mortgage for many years, refinancing to a 15-year loan involves a substantial payment increase. You can run several scenarios through ShopRate's mortgage payment calculator. For example, a $300,000, 30-year mortgage at your current rate of 5.375% would carry a principal and interest payment of $1,680. That same 30-year mortgage at 4.375% comes with a payment of $1,498. With its half percent lower rate, a 3.875% 15-year loan carries a heftier payment of $2,200. Finally, if you chose a 5/1 ARM at 3.5%, the payment would be $1,347.

You can run these different programs through a pre-qualify calculator to see how likely you are to be approved. For example, if your income is $5,000 per month and you have no other bills, you could be approved for a 30-year loan of over $300,000 at 3.5%, so you can feel pretty confident of being approved for that 5/1 refinance. However, you qualify for less than $200,000 with the 15-year program at 3.875%. So if you want a 15-year loan and need to refinance $300,000, you may have a hard time getting approved.


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