Many homeowners think about switching from a 30-year to a 15-year note. It sounds good, right? To be done repaying the loan on your house in 15 years instead of the remaining term you currently have feels great to think about. Most homeowners have a new home loan within the last five years because they have refinanced or purchased a new home during that time. Chances are these same homeowners have a pretty good interest rate, too. So, what’s the best way to determine if you should reduce your term to 15 years; saving you potentially 10 to 15 years’ worth of payments?
Let’s assume the following variables for the comparison:
Loan amount: $250,000
Remaining term: 27 years
Current interest rate: 4.25%
Current P&I payment: $1,229
Loan amount: $252,500 (includes est. of $2,500 in loan costs financed)
New term: 15 years
New rate: 3.25%
New P&I payment: $1,770
As you can see the 15-year payment is pretty aggressive. It’s more than $500 higher than the current loan payment. That can be scary depending on your cash flow. It’s basically adding a nice long car payment to your debt structure, right? Before you get discouraged, let’s dig a little deeper.
Let’s add up the total amount of payments remaining. To do this you multiply the P&I payment by the number of payments remaining. The current loan has 324 payments remaining (27 years x 12 payments per year). That’s a total of $398,196 in remaining payments. Yikes! The new loan has 180 payments (15 years x 12 payments per year). That’s a total of $318,600 in remaining payments. That’s $80,000 less than the current term.
In this scenario, you would be sacrificing some disposable cash in exchange to save $80,000 in payments. You could look at this as an investment because the 15-year term is a commitment that doesn’t offer the same flexibility as the 30-year term does.
Let’s dig even a little deeper. What if you paid extra on your current loan? To create an apples-to-apples comparison, you would have to assume you would pay the loan off in 180 payments (15 years). That means you would pay the required amount of principle and interest against the current rate of 4.25 percent. This results in a payment of $1,896 per month; $341,280 for the 15 years total. That’s about $23,000 more than if you refinanced to a 15-year term at the 3.25 percent.
In this scenario, you are sacrificing about $23,000 in savings to not refinance. That’s pretty significant. Yes, you save on a small amount of closing costs by not refinancing but even if you subtract that out, you are still over $20,000 in wasted interest payments. The main thing to ask yourself here is, “Is $20,000 in lost savings worth the flexibility?” Remember in this scenario, you are simply paying extra on your current term. If you had to cut back on expenses for any reason, you could always make your normal amortized payment which would be about $600 less ($1,896 vs. $1,229).
The best way to make this decision is to work through your scenarios with an experienced loan officer. Not all lenders are created equal, and unfortunately, not many loan officers will provide you with an in-depth consultation that keeps your best interests a priority. Feel free to call Mike or his team to discuss your current loan. If we can save you money, we will.