With interest rates still at a historic low, some homeowners may consider refinancing from a standard 30-year fixed rate mortgage to a 15-year mortgage. Nationally, it seems a lot of folks are doing just that—the Mortgage Bankers Association says that one in four refinance applications in March was for a 15-year loan, up from 12.2 percent the year before.
There are a few key advantages to this strategy, says Jason Crigler, residential mortgage specialist with Crown Mortgage in Charlottesville.
First of all, 15-year mortgages generally have lower interest rates than 30-year mortgages. Right now, interest rates on a 15-year FRM (fixed rate mortgage) stand at 4.4 percent, compared to 5.07 percent for a 30-year FRM, according to the most recent available figures from Freddie Mac. Both rates have been declining on average since January 2009, and may continue to fall.
Why the differing rates? It’s because “the shorter the term, the less likely inflation will become a factor over time—it’s a less risky investment for the lender,” explains Crigler. “But when a loan is spread out over the course of 30 years, inflation becomes a bigger concern. The interest rate has to absorb those fluctuations.”
The second plus to a 15-year FRM is that while the monthly payments are higher—though not double, notably—the term of the loan is half (down from 360 to 180 months), so the borrower saves a huge amount in financing charges. A larger portion of each month’s mortgage goes toward paying down the principle, not interest.
As an example of just how much savings, consider the following: The monthly payment on a 15-year FRM of $200,000 at 4.4 percent is $1,520. The monthly payment on a 30-year FRM for the same amount at 5.07 percent is $1,082. That additional $438 per month for a 15-year FRM might seem painful in the short term until you consider the long term savings. Interest paid over the full term of that 15-year FRM is $73,561 compared to a whopping $189,598—nearly the amount of the loan itself—for the 30-year FRM.
One would think that the low-low-low interest rates would drive demand for 15-year mortgages, but Crigler says that hasn’t been the case in the Charlottesville area. Not only do a lot of people erroneously assume the monthly payments will be double—they’re not, they’re more like 25 to 40 percent higher—many can’t afford increased monthly payments of anything right now, given the current economy.
But a 15-year mortgage is a great option for those looking to refinance or who’ve already paid down a portion of their 30-year FRM. “I love seeing clients choose a 15-year fixed over a longer term loan, if they can afford it and it makes sense for their situation,” he says.
If you’re concerned you can’t afford a 15-year mortgage, the lender will remove any guesswork by taking you through a much more stringent application process to determine whether your income qualifies. This is a sharp contrast to the application process of years past, when anyone “with a pulse could basically qualify for a loan,” says Crigler. “These days, it’s a lot tougher to get into a real estate situation you can’t afford.”