Should You Refinance With a 15-Year Mortgage?

Interest rates have dropped to enticing levels again, prompting many to think of refinancing. In fact, if you've been in your home a while you may be considering refinancing with a 15 year mortgage, since rates are around 4.5%. But refinancing involves closing costs. Is it worth it?

Let's take an example. Let's say that you bought your house 5 years ago, borrowing $300,000 at 6% for 30 years. Your mortgage payments are $1,800. Now your principal balance is about $280,000. If you refinance with a 15 year fixed mortgage at 4.5%, your payments will go up from $1,800 to $2,135. Why do they go UP, you ask? Because you're now scheduled to pay your house off in 15 years, instead of the 25 remaining on your current mortgage.

But what about the closing costs on the refi? Most people roll the closing costs into the loan amount when they refinance. Let's say the closing costs are 2.5% of your balance. So now you're going to start the 15 years at $287,000. That changes your payment to $2,195.

What if you skipped the refinance and took that $2,195 to pay your current mortgage? Each month you would be paying an extra $395 on your mortgage, which would go straight to reducing the principal balance. Your mortgage would be paid off in 17 years. That's two more years of payments than if you refinanced. Two more years of month payments at $2,195 is more than $52,000. That's a lot more than the closing costs you saved.

But that assumes that you're going to live in your house until the loan is paid off. What if you sell it between now and then? Where is the break even point? If you refinance, your principal balance goes up to $287,000 now. If you don't, it stays at $280,000. But if you refinance, your interest rate is lower, so more of the $2,195 payment goes to paying down the principal and the balance goes down more quickly. It turns out that in about 2 years, the principal balance becomes less than if you didn't refinance and paid that same amount on your existing mortgage.

So if you expect to stay in your current home for more than two years, it's worth it to refinance to a 15 year loan.

What about your scenario? Most of these numbers are based on percentages -- the interest rates, the closing costs. If those are accurate for you, then the numbers should work out to about a 2 year break-even point regardless of your current principal balance. If any of those percentages is different than this example, it will change things. Let's say that your current interest rate is higher than 6%. That would mean that a 4.5% interest rate would save you more and it will take less time to reach the break even point. What if closing costs are more than 2.5%? Then it will take longer to pay them off, putting the break even point a little further away.

If you are currently in your forever home, then now is probably the time for a refinance loan. If your family is growing, there may never be a better time to buy a new home than right now.