With interest rates now on a slow grind higher, the spread in rate between a 30 year and 15 year mortgage has grown to just shy of 1%. This spread in rates has many opting for the more aggressive pay down plan to take advantage of the interest savings.
There are several key points to think through when considering shortening the term of your home loan. The following non-inclusive list will help you profile your situation to decide what is best:
• Payment affordability: This is the most crucial determining factor and should never be ignored. Since shortening the term of your loan will most often times result in a higher monthly payment, if your budget is currently stretched, you may be better off keeping the longer term loan in place.
• Age: We typically see our clients become more aggressive with their mortgage reduction plan as they get older. Generally, people in their 40s and 50’s realize the desire to own their homes when they retire. A shorter-term loan with a lower interest rate is one way to achieve that goal.
• Future plan for the home: This step is listed to point out that it is not as big of a consideration as many people think it is. Some say they will never keep their home long enough to pay it off, so why would they pay the loan down more quickly? The reality is that increasing equity in your home is one way to store net worth. If someone plans to downsize in the future, the equity they have in their home can transfer to their next home or be used to supplement retirement income.
• Consider better use of the money: Paying down a home essentially transfers net worth from cash into equity. If the cash can be used to increase net worth in other ways, that should be considered. In many cases, it can be better served by reducing other consumer debts.
• Forced savings: Shortening the term of your loan is essentially forcing you to pay down your home more quickly, which in turn will more rapidly increase your equity. This a great way for those who have a hard time making additional principal reduction payments to be required to pay down their home loan more quickly.
A case study / example of converting a 30 year term to a 15 year mortgage:
Current Loan Balance: $247,000
Current Interest Rate: 4.375%
Term Remaining: 25 years 3 months
Current principal & interest payment: $1,348.04
Remaining Interest Due on Loan: $161,456
No-Cost Rate for 15 Year Loan: 3.5%
Proposed Principal & Interest Payment: $1,765.76
Proposed Payment Increase: $417.72
Years Saved on New Loan: 10 Years 3 Months
Total Interest on Proposed 15-Year Loan: $70,836
Total Interest Saved: $90,620
Generally speaking, people strive to pay their homes off to save interests costs and to increase cash flow at some point in the future. However, there is more than one way to accomplish these goals. If you are questioning whether a 15-year mortgage is right for you, call us for a free mortgage review. We will answer your questions and help you to analyze the differences to determine what is best for your situation.