If a 15-year mortgage is too aggressive and a 30-year mortgage isn't aggressive enough, look into a 20-year mortgage to take advantage of the low mortgage rates …
Last month I looked into refinancing the mortgage on our primary residence. We had bought the house in 2010, and our then-great rate on a 30-year fixed-rate mortgage was a bit high by 2016 standards.
On our previous house, when rates dropped a few years into the mortgage I refinanced to a 15-year mortgage. The payment was only a bit higher ($150/month or so) and over the course of the mortgage it has saved us well into five figures in interest.
15-year mortgage might be too aggressive
With our current mortgage, the principal balance started nearly twice as high as on our first house, and the payment was about 80% higher than on our first house. When the lender quoted the payment for a 15-year mortgage, it was high enough that I hesitated pulling the trigger on it.
After a few days, we had reached the conclusion that we'd hold off on refinancing because committing to the higher payment was something that we were uncomfortable doing. Even though we'd save a ton of interest in the process (like $70,000+) the extra cash flow out was unnerving.
20-year mortgage = perfect match
The lender called back with a quote for a 20-year mortgage. This is a less-common term for a mortgage, not reported nearly as widely as a 30-year or a 15-year.
This particular product was hard to refuse, though: The payment was a few dollars less per month, and it allowed us to jump from our current 23.5 years left to 20 years left. We'd still save around $50,000 in interest over the course of the mortgage!
Nice, huh?
Comparing mortgages of different terms
In general, the longer term a fixed-rate mortgage has, the higher the rate. This is because the lender puts itself on the hook for longer; rates can change more (against them) over a longer period of time.
So shortening the term of a mortgage with a refinance helps to get a lower rate. But, since the principal is paid back over a shorter period of time, the payments are higher.
To show the comparison, let's consider a $200,000 mortgage 30-year fixed rate mortgage with a rate of 5%, which is in the ballpark for 2010. The payment for this mortgage is $1073.64.
Let's consider refinances at today's rates six years into this mortgage. The principal balance after 72 payments is $179,870.95. From here, 10-, 15-, 20-, and 30-year rates are 2.75%, 2.95%, 3.375%, and 3.625%, respectively. Let's also assume that $3,000 in closing costs are rolled into the new loan.
The table below compares holding the current loan in the top row (24 years remaining of the 30-year loan at 5%) with the refinance options.
| Term (yrs) | Rate | Payment | Interest paid | Payment diff. | Interest savings |
| 24 | 5.000% | $1,073.64 | $129,340.28 | 0 | 0 |
| 10 | 2.750% | $1,744.79 | $26,069.45 | +$671.15 | $103,270.83 |
| 15 | 2.950% | $1,258.47 | $42,938.45 | +$184.83 | $86,401.83 |
| 20 | 3.375% | $1,048.86 | $67,727.45 | -$24.77 | $61,612.83 |
| 30 | 3.625% | $834.06 | $115,437.05 | -$239.57 | $13,903.23 |
The right two columns are the difference in the monthly payment from the current loan, and the total interest savings over the life of the loan.
The 10-year loan has the largest interest savings and the largest payment (over 60% higher than the current payment). This could be a great option for someone who got a sizable raise, or inheritance, and could easily throw that amount at the mortgage.
The new 30-year loan has the lowest payment (more than 22% lower) and also the lowest interest savings. (There's an extra 6 years of interest payments!) This option frees up cash flow: nearly $240/month that can be put to another use.
The 15-year and 20-year loans are closer calls. The 15-year loan has a payment that's a bit more than the current payment and still a boatload of interest savings. The 20-year loan has a slightly lower payment than the current payment and about $25k less interest savings than the 15-year — but still a boatload! (Just a smaller boatload.)
In my (unsolicited) opinion, the 20-year mortgage offers a lot: a slightly better payment and finishing up the loan four years early. Though it's not clear here, another advantage of shorter-term mortgages at these rates (20 years and shorter) is that the payments immediately are more principal than interest! That means a faster buildup of equity in the house.
Consider refinancing when rates are in the basement
As of now (September 2016) rates are awfully low. Whether they have more downside or not is anybody's guess, but it's clear that there is a lot of upside.
You needn't have gotten your mortgage a long time ago to benefit from the low rates. We've refinanced on two separate mortgages within seven years of getting them in the past fifteen years. For a time in 2013 rates were similar to what they are now, but now they're matching those 2013 rates.
Check into this great opportunity to save a lot on interest, to reduce your monthly payment, to reduce the number of payments — or all three!
You have a lot to think about when refinancing. Your first step should be to really understand why you are doing it. Is it to lower your monthly payment or to save on interest. If it’s to save on interest, you need to factor in closing costs into the equation. In some cases, you could be better off keeping your current loan and making additional payments if closing costs are high.
Sounds like you found a great solution for your situation.
Thanks Jon for stopping by! Good observation about the closing costs. We considered them and they were negligible compared with the the interest savings.