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Is it better to refinance to a 15- or 20-year loan

By Adam Funk Aug 17, 2016

A mortgage payment is otherwise known as a “minimum monthly payment”. You can choose to pay more if you want to pay the loan off faster. The real reason to choose a 15 or 20 year mortgage instead of a 30 year is when you can get a better rate by committing up front to the higher minimum payment. Interest rates are based on the markets which fluctuate. So there are times when there is a significant rate savings with the shorter term, while other times it may be negligible. For example today the 20 year rate is .375% better than a 30 year which is good and should be considered, while six months ago the market rates were about the same. If rates are about the same you are better off taking the longer 30 year, which gives you flexibility to have a smaller payment in lean years.

I have a client that is refinancing their $200,000 30 year mortgage. The markets are in their favor to lower from their current 4.25% to a 4.00% fixed rate on a 30 year with no closing costs. That’s free money and everyone should do that if they can. Then we took it a step further and looked at the 20 year fixed rate which is 3.625%, a bonus .375% rate savings ($750/year interest savings) for the shorter term. Going lower to a 15 year only saved an additional .25% which seemed negligible and was pushing them past their comfort zone on the monthly payment. They are the personality who would like to pay off their mortgage faster and they are balanced with other savings and retirement accounts. So they are choosing to go with the 20 year fixed rate. Their minimum monthly payment will go up $192 which they determined is manageable and worth it to shave 10 years off.

Rate Term Min Mthly Pmt Total Payments Interest Savings (before tax deduction)
4.25% 30 year $983 $353,880 Currently has
4.00% 30 year $954 $343,440 $10,440 over life of loan, ~$500 first year
3.625% 20 year $1,172 $281,280 $72,600 over life of loan, ~$1,250 first year
3.375% 15 year $1,412 $254,160 $99,720 over life of loan, ~$1,750 first year

And when I say free, it means closing costs are absorbed by the bank when choosing the higher rates shown. It does not mean closing costs are rolled into the loan, such as 200,000 loan becomes 203,000 loan. Typical closing costs are about $3,000 not including the brokers commission. The rate sheet in this situation shows they could have gotten 3.375%, .25% better rate but they would have to pay $2,850 of closing costs. Quick breakeven math shows the lower .25% rate would save them $26 per month. ($2,850 divided by $26 = 109 months = 9.1 years). So the breakeven benefit of choosing the lower rate with closing costs is about 9 years and there is no guarantee they will still be in the same mortgage after 9 years, such as if market rates continue going down and they refinance again into a 15 year mortgage, or they move.

Ideally I recommend a 15 year fixed rate as it is reflection of good judgment when purchasing a modest house that does not make you broke. I also recommend you speak to a certified financial planner for the best debt payment strategy in your specific situation. – Coach Funk

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