5-Minute Fix: Picking The Right Mortgage Term When You Refi

Many of our clients are taking advantage of incredibly low mortgage rates to refinance.

But how do you decide between a traditional 30-year fixed mortgage and a shorter 15 or 20-year term?

A shorter-term mortgage, like one lasting only 15 years, will offer a lower interest rate and will, of course, be paid off sooner due to the shorter term. However, payments may be considerably higher than with a 30-year term mortgage.

For example, financing $250,000 at 4% over 30 years will result in a $1,193 monthly payment.  The payment jumps to $1,771 when amortized over only 15 years at a lower 3.375% rate.

However, you’ll pay less interest over the years with a shorter mortgage.  Total interest paid over the life of the mortgage using the example above is $179,673 for the 30 year mortgage and $68,941 for the 15 year variety.

But does that mean you should always stretch your budget to afford the 15 year mortgage?

Not always.  While refinancing into a shorter 15-year mortgage can save thousands of dollars for many homeowners, it can be a dangerous choice for other borrowers.

With a 15-year mortgage, you are on the hook to pay the higher payment each month.  If you lose your job, have unexpected medical expenses, or run into some other financial difficulty that compromises your income, you may put your home at risk.

With a 30-year mortgage, your monthly payment is lower, giving you more “margin for error” if something should go wrong. That may make the 30-year mortgage the better choice for many homeowners.

Tips for making the right choice

A shorter 15-year mortgage makes most sense if you have ample and stable income, and a robust emergency fund available should you need extra cash.

The traditional 30-year mortgage is better if you need more “wiggle room” in your budget, have variable income, or less money available to call on in emergencies.

And don’t forget that, at no extra cost, you can always make extra principal payments on a 30-year mortgage to pay it off earlier and cut your overall interest costs.

Making one extra payment per year cuts 4 years off your mortgage and saves $26,842 in total interest costs.

Two extra payments per year cuts 7 years off the mortgage and saves $46,241 in total interest costs.

Three extra payments each year chops 9 years off the mortgage term and saves $61,001 in total interest costs.

Best of all, while you are always welcome to make extra payments, there’s no obligation to do so, adding extra flexibility to your budgeting.

 

About Mari Adam

Mari Adam, Certified Financial Planner™ and President of Adam Financial Associates Inc, has been helping individuals and families chart their financial futures for over twenty-five years. Have a question about your financial situation? Ask Mari!

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