With mortgage rates at near record lows, now may be a good time to refinance your mortgage, especially if your rate is 4.5% or higher. Instead of starting a new 30 year period of debt however, have you thought of refinancing to a fifteen year mortgage? The amount of money you will save over the fifteen year difference is significant. Let’s take a closer look.
I am using some basic numbers in this example, but you will get an idea for what is possible in your particular situation. Just multiply by 3 for $300,000 or 4 for $400,000, etc. depending on your loan amount. Let’s take a look at a mortgage of $100,000 to show the savings on a 15 year mortgage.
A $100,000, 30 year mortgage at 4.5%, has the principal and interest shown in the chart below. I am using a 4.5% interest loan for comparison because 4.5% is a fairly common rate if you bought or refinanced shortly after the financial crisis of 2008-09. (I used Bankrate.com to do these calculations. You can use it yourself to get your numbers.) If you have yet to refinance your mortgage at low rates, you are paying even more than the chart shows.
Look at the amounts of interest and total amounts paid on these loans! The principal is $100,000 in all cases, but the total amounts you pay back to the bank are quite different. They range from $125k to $182k. With a 30 year mortgage at 3.5%, you will pay 61k on every 100k borrowed!
You will see I have used 3.1% interest as the rate for the 15 year term. That’s today’s going rate for a refinance. The 2.75% rate you see advertised is for a new 15 year loan. The disadvantage to a 15 year mortgage is a larger monthly payment, but it is a good idea if you can afford it.
Looking at the chart, we see the total interest on a 30 year at 4.5% is 82k. Taking out another 30 year mortgage at today’s rate 3.5% will save you $21,000 in interest. The better option, however is the 15 year mortgage. With a fifteen year at today’s refinance rate of 3.1%, you will pay interest of $25,172. That’s 57k less than the 30 year at 4.5% and a savings of $36,000 over choosing the 30 year, 3.5% refinance.
Thirty-six thousand is nice, but it’s not the entire benefit you will gain from choosing the fifteen year mortgage. A 15 year mortgage means you will be debt free 15 years earlier! That’s significant for building your wealth. Without a mortgage, you can invest that money to accomplish other goals.
Rather than paying the bank $449 every month, let’s invest that amount and calculate how much you could have in an investment account instead. Investing $449 per month at 7% return per year for fifteen years comes to a total of $142,316. Having this much money saved at the end of the thirty year term, as opposed to only then becoming debt free is very significant!
|At Year||30 year refinance||15 year refinance|
|0||$100,000 owed||$100,000 owed|
|15||$62,813 owed||$0 owed, $125,172 paid|
|30||$161,656 paid, $0 invested||$142,316 invested||Difference of $178,800|
Let’s say you are looking to refinance your house, and you have a small child. By taking the shorter mortgage, you will have the mortgage paid off by the time your child starts college. Having no mortgage will free up a large portion of income that can be used for their schooling. Alternatively, not having a mortgage fifteen years from now will enable you to make significant additions to your retirement savings. If you were to sell the house before the fifteen years is up, you will have a larger equity stake and will have saved money by paying less in interest over the time you do own the house.
Hopefully you can see the benefits of the faster payoff. The trouble with doing this is if you really can’t afford the higher payments. In that case, refining your cash flow would be a wise first move. For those that can afford a higher payment, paying more now may open up other opportunities to invest or spend your money.
For comments or questions, reach out on twitter: @iammrmarshall