Mortgage rates just keep heading lower, defying expectations. Currently, the average rate is 3.56 percent for a fixed-rate 30-year loan. That’s nearly a half a percentage point lower than the rate just a year ago, according to Freddie Mac.
Meanwhile, home values have been heading higher. The S&P/Case-Shiller home price index of 20 major metro areas has gained 5 percent over the past year and is up 26 percent since late 2012.
The combination means refinancing is now a very good option for more homeowners, especially those that have at least 20 percent equity in their homes.
With rates so low, it's also a good time to consider refinancing into a 15-year mortgage instead of a 30-year mortgage.
Typically, homeowners prefer 30-year mortgages. Halving the payback period often means making a much higher monthly payment. But Andrew Rafal, founder of Bayntree Wealth Advisors in Scottsdale, Ariz., notes that today’s super low rates makes a 15-year mortgage less of a financial stretch.
Consider this. Let's say you took out a $250,000, 30-year mortgage at a 5 percent interest rate 10 years ago. Your monthly payment would be about $1,350. Now let's say you refinance that mortgage now into a 15-year loan at the recent average rate of 2.81 percent (for 15-year loans). Your monthly payment would rise to about $1,425—an increase that could be palatable for you.
For the extra $75 per month, you’d save about $80,000 more in total interest costs than if you had chosen to refinance into a 30-year loan.
“The interest savings on a 15-year loan are an eye-opener,” says Rafal. “For people nearing retirement, using the shorter term to get rid of the debt before you stop working is smart.”
Rafal stresses that the 15-year loan only makes sense if you have the extra cash flow to comfortably afford the higher monthly payment. Mortgage data firm HSH.com has a free online refinancing calculator to help you run the numbers.
Qualifying for a 15-Year Mortgage
If refinancing interests you, Ellen Steinfeld, managing director of consumer lending at TIAA Direct online bank says you would be in line for "attractive rates" if you have at least 20 percent equity and a FICO credit score of at least 700. FICO scores range from 300-850. According to mortgage data firm Ellie Mae, the average FICO credit score for borrowers who refinanced for a conventional mortgage recently was 732.
Ellie Mae also reported that borrowers whose refinancing applications were approved, typically had a mortgage payment that was 25 percent or less of their income. Their total debt payments (including the mortgage) added up no more than 38 percent of their income on average.
Keep in mind that taking out a new mortgage will come with closing costs. You can choose to pay upfront, or accept a slightly higher interest rate if you don’t want to use cash to cover your closing costs. The good news is that comparison-shopping from different lenders is now easier. Beginning last fall all lenders must give potential borrowers a standard Loan Estimate that runs through all loan fees.
Pay Your Loan Back Faster
If you have 15 years or less remaining on your existing mortgage you may not want to refinance, says Germi Cloud, a financial advisor in Huntsville, Ala. “You’ve paid most of the loan’s interest costs in the first 15 years, so you don’t want to start paying more interest now.”
Cloud says a better move would be to accelerate the payback on your existing mortgage. Let's say you have a monthly mortgage of $1,265. You're paying back a loan of $250,000 that charges a 4.5 percent interest rate. If you added $200 a month to your monthly payment, you could reduce the payback on a 15-year mortgage to around 12.5 years. This would also save you nearly $13,000 in interest costs. If you added $300 a month you could shorten the payback timeframe to about 11 years and save more than $16,000 in interest.
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