Lower interest rates have made refinancing a smart option for many homeowners. You might be able to lower your monthly payment or even “cash out” your mortgage, letting you consolidate other debts or fund large expenses, such as home renovations or your children’s college educations. Lower refinance rates are also making it possible for homeowners to refinance their 30-year loans into 15-year loans.
We asked Norman Boone, founder and president of Mosaic Financial Partners in San Francisco, and Kyle Morgan, an associate financial planner at Mosaic, for more information about the pros and cons of 15-year loans. Boone and Morgan are members of NerdWallet’s Ask an Advisor network.
When should people consider refinancing to a 15-year loan?
Kyle Morgan: A person should consider a 15-year loan if they have steady, projectable income, a household budget that can afford the larger monthly payment, and a strong desire or need to pay off their mortgage sooner.
Norman Boone: The most likely candidates for a 15-year loan are borrowers who are nearing retirement and want to avoid having mortgage payments when they get there. Another less likely group would be those who have an income stream — an annuity or royalties come to mind — that will end sometime before 30 years.
What are the advantages of this strategy?
Norman Boone: The attractions of a 15-year mortgage are that the loan will be paid in full sooner, the interest is usually lower than a similar 30-year loan, and the total cost of the loan — aggregate of interest paid — is less than a 30-year loan.
Kyle Morgan: Potentially tens of thousands or more of savings in interest payments over the length of the loan. In addition, paying off the loan sooner frees up cash flow. It’s a risk-averse, conservative approach to your personal balance sheet.
What are the disadvantages?
Norman Boone: The argument against a 15-year loan [is] that the payments are larger, and therefore there is less flexibility if, at some point in the future, making those larger payments becomes difficult.
We have sometimes recommended to clients that they get a 30-year loan and make payments as though it were a 15-year loan, thus paying it off earlier, but retaining the flexibility to make lower payments if necessary at some point in the future. The only disadvantage of that is the usually higher interest rate of the 30-year loan.
People would not be good candidates for a 15-year loan if they aren’t sure they can make the higher payments, or [if they] are confident they can invest money and achieve returns in excess of the interest rate on the mortgage. If you can earn 8% and can borrow at 4%, why would you not borrow the money for as long as possible?
Kyle Morgan: There is opportunity cost risk associated with applying a larger amount of cash to the interest and principal of the loan instead of into a diversified investment portfolio, or other investment, that could potentially earn more, over the 15-year period, than the interest you are paying on the loan. This cost is amplified by federal and state tax codes that provide favorable treatment to homeowners via the mortgage interest deduction. In a low interest rate environment, having debt isn’t necessarily a bad thing.
Other disadvantages include potential cash-flow issues caused by higher monthly payments and the actual cost of refinancing — usually a couple thousand dollars at closing — plus the hassle of gathering and providing all of the necessary documentation for underwriting.
What are some tips to best take advantage of the 15-year option?
Norman Boone: It still makes sense to get the lowest interest rate possible. Whether for 15 or 30 years, why pay it to someone else if you don’t have to?
If you refinance, don’t just get a new 15-year loan. Try to get the new loan’s last payment to coincide with the last payment date of your current loan. For example, if two years ago you financed your house with a 15-year loan, you now have only 13 years remaining. Don’t refinance that with a new 15-year loan; get a 13-year loan, so that your payment will still end on the date you originally planned. If the lender won’t do it, just make extra principal payments — for example, an extra $100 each month — so that it will work out as though it were a 13-year loan.
Kyle Morgan: Shop around. Contact a mortgage broker who has access to multiple lenders and can help find the best product to fit your needs. Talk to your bank. For higher-net-worth individuals, your bank may provide certain perks, such as rate discounts, if you are holding a certain level of assets with them.
What are some other important things consumers should know before they decide?
Kyle Morgan: Know what you are getting into. This is a big financial decision that requires some consideration. Talk to your financial advisor to make sure a 15-year loan is the right solution for achieving your goals.
Norman Boone: Fifteen-year loans are not for everyone, primarily because of the higher payment required compared to a 30-year loan. If you can afford the higher payment and you want to be out of debt by a particular date, then a 15-year loan might be very attractive.