Time to Ditch Your 30-Year Mortgage?

CBS MoneyWatch

If you've been mulling refinancing your mortgage, it's hard not to love the news that the interest rate on a 30-year fixed rate mortgage has dipped down to 4.7 percent. That's just silly cheap. Not only is 4.7 percent a 2011 low, it is 30 percent less than what a 30-year fixed rate loan cost just 5 years ago. With the average interest rate on outstanding mortgages sitting at 6 percent, refinancing into a 4.7 percent loan can yield significant savings.

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But there's an intriguing alternative that could end up saving you even more: Consider a 15-year mortgage rather than a 30-year. Freddie Mac reported last week that the average interest rate on a 15-year mortgage is 3.9 percent. While the 15 year is always a bigger burden on your current cash flow than a 30-year, today's rock-bottom rates today make it increasingly affordable. The payoff is tens of thousands less in interest payments over the course of the loan, building your equity a whole lot faster, and, if you happen to be of a certain mid-life age, helping you get the mortgage polished off before retirement, a key planning goal for peace of mind.

Why 15-Year Mortgages Are Worth a Serious Look

3.9 percent is 3.9 percent. One of the obvious hurdles with a 15-year loan is that because you are paying it off twice as fast as a 30-year, your monthly payments are always going to be higher than the longer term loan. But with the rate on a 15-year mortgage now at 3.9 percent, it's more affordable than ever. As recently as late 2007 a 15-year cost more than 6 percent, so the price has come down more than one-third.

A big spread compared to a 30-year mortgage. The interest rate on a 15-year mortgage is typically about half a percentage point lower than what you'd pay for a 30-year loan. That means today's 0.80 point spread is an especially good deal.

A good use for idle cash. Paying down your mortgage can make a lot of sense regardless of what your cash is earning. The peace of mind that comes from knowing you're mortgage-free can supersede all sorts of financial considerations. But with your bank savings probably earning less than 1 percent, using some extra cash to pay for the higher monthly payments on a 15-year can be a particularly good use of funds now. Before the howls start, let me be clear that I'm not talking about touching your emergency savings. Whatever you deem as necessary to have in liquid savings stays untouched. But if you've got some excess cash, investing it in your mortgage becomes a viable possibility.

Let's say you have a $350,000 mortgage at a 6 percent interest rate. That calculates to a monthly payment of $2,098. Assuming you're five years into the loan, the remaining balance would be $325,000. Refinance that into a 4.7 percent 30 year loan, and your monthly payment dips to $1,687. That's a nice monthly savings of about $400. (Of course, the smarter refinancing step is to not reset your payment clock all the way back at 30 years, but instead refinance into a mortgage that matches the remaining years on your existing loan. So for example, if you're five years into a 30-year mortgage, refinance into a 25 year, rather than 30 year. You'd still shave about $250 a month off of your payments without having to start paying off a 30-year loan all over again.)

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But if you've got extra cash flow, you could instead consider refinancing into a 15-year mortgage. Yes, even at 3.9 percent your payments would be higher than what you're currently paying: $2,571 vs. $2,098. The payoff comes in the interest savings over the life of the mortgage. If you start with a 6 percent 30 year mortgage that you refinance to a 4.7 percent 25-year loan, after five years your total interest charges for both loans would be around $331,500, compared to $405,000 if you stick with the original 6 percent loan for the duration. But if at the five-year mark, you instead opted for a 15-year loan, your total interest payments over the entire 30 years would be about $208,000. That's nearly $125,000 less than if you had refinanced into a 25-year, and almost $200,000 less than if you'd stuck with the original 30-year. It also shaves 10 years off of your payback period, and given the tenuous nature of employment once you hit your late 50s and 60s, not having a big mortgage payment hanging over your head at that juncture can be a huge help.

Obviously, you need to run the numbers for your own situation. The mortgage calculator at Bankrate.com will spit out all sorts of data, including an amortization schedule showing your total interest charges throughout your loan term. Or you can compare two loans side by side using Bankrate's refinancing calculator.

Why You May Need to Do a Cash-in Refinance

For a conventional mortgage, refinance lenders are going to insist you have at least 20 percent equity. If you are sold on staying in your home but lack the requisite 20 percent equity slug necessary to refinance, you might want to consider a cash-in refinance. That is, you bring some extra cash to the table to buy down your mortgage amount so you can meet the equity threshold for the refinanced loan. In the first quarter of this year, 21 percent of refinancings involved consumers borrowing less than the outstanding balance on their existing mortgage, according to Freddie Mac data, meaning those borrowers brought cash to the refinancing. The median appreciation rate on refinanced mortgages in the first quarter of 2011 was a negative 6 percent, which goes a long way to explaining the need to bring some cash to the closing.

Another cost to weigh, of course, is the fact that refinancing isn't free. The standard fee for refinancing these days is 0.70 percent of the loan amount. Get an estimate early in the application process and plug that into your calculations.

The Do-It-Yourself 15-Year (or Less) Mortgage

Of course, there's a backdoor way to get your mortgage paid off in 15 years or less: Stick with a 30-year and make the personal commitment to send in extra principal payments. If your current 30-year fixed is 6 percent or higher, refinancing into a lower-rate 30-year and then sending in extra payments can save you plenty. But the cheapest way to pull this off is to keep your existing mortgage and send in extra payments. No fees to do that, though your interest meter will continue to run at an above-market rate.

This is indeed an incredibly smart alternative that leaves you plenty of flexibility if other financial needs crop up. But that flexibility also has its drawbacks, chief among them that it relies on you to save for and make those extra payments. For that reason, you could consider opening a new bank account into which you make automatic deposits each month or quarter that are to be exclusively used to speed up your mortgage payments. Or you just might want to take a look at whether getting into a 15-year is an affordable way to push you to get your mortgage paid off faster and cheaper.

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