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Will A Short Term Reduce Costs?

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Posted On: 10/14/2015

Question: With mortgage rates around 4 percent we are thinking of refinancing with a 15-year mortgage. Is this a good way to cut interest costs?

Answer: Let’s divide your question into two parts: First, Do you really need to refinance? Second, would you be better off with a 15-year mortgage?

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For refinancing to make sense you need to get a material benefit, such as a lower mortgage rate, smaller monthly payment, or a switch from an adjustable-rate mortgage to fixed-rate financing. In considering these options you need ask how much it will cost to refinance versus how much you will save each month. For instance, if it costs $3,000 to refinance and you save $150 a month, then you want to stay at the property for at least 20 months for the refinancing to make sense.

Also, if you’re going to keep your current mortgage then you might simply want to create your own 15-year mortgage payoff program.

This can be done by looking at the monthly payment coupon. For most mortgages there is a place where you can indicate that you want to make an extra principal contribution. As an example, let’s say that you have a $250,000 mortgage at 4.5 percent. Across 30 years with a fixed-rate loan your monthly cost for principal and interest is $1,266.71. To pay off this loan in 15 years – if we start in the first month – you will need to raise your monthly payment to $1,912.48. That’s an increase of $645.77. If a larger payment of this magnitude is comfortable, your projected interest cost over the life of the loan will go from $206,016 to $94,246.

The nice aspect of this do-it-yourself approach to 15-year loans is that your obligation to the lender is to pay at least $1,266.71 per month for principal and interest; if you run into a tough financial period you’re not obligated to make more than the required payment.

If refinance then your interest rate is likely to be lower in two ways: First, today’s mortgage rates may be lower than the rate that you now have. Second, rates for 15-year financing generally are lower than the rates for 30-year mortgages. In late summer, according to Freddie Mac, the rate for 30-year, fixed-rate financing was 3.84 percent; the fixed rate for a 15-year mortgage was 3.06 percent. That’s a difference of a little more than three quarters of a percent, a big deal.

Let’s say that you go from a 30-year, $250,000 mortgage at 4.5 percent to a 15-year, $250,000 mortgage at 3.06 percent. The 30-year loan will have a monthly payment of $1,266.71 for principal and interest while the 15-year loan will require $1,733.68. By refinancing you’ll have up-front costs to get a new loan, but because you have a significantly lower interest rate you obtain a solid monthly savings. In this example the potential interest cost for the 30-year mortgage is $206,016 versus $62,062. That’s a difference of more than $140,000 in potential interest savings – if you can afford the higher monthly payments.

The discussion above shows how the options might compare but what really counts are your finances and personal preferences. For details and specifics speak with lenders in today’s market.

Peter G. Miller is the author of The Common-Sense Mortgage and a veteran real estate columnist. Have a question? Please write to peter@ctwfeatures.com.

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