Sometimes in the midst of trouble, we try to solve the little problems instead of focusing on the big ones.
If you want to improve your financial picture start with the big categories. Housing is usually the largest expense for most people.
Right now, mortgage rates are still in the 3-3.5% range. The possibility that the Fed raises interest rates still looms in our future, so buying or refinancing a home may not get any cheaper.
You may decide to refinance now, but maybe you can't decide between a 15 year or a 30 year mortgage. There are pros and cons for both. So which one?
Could you get the best of both worlds?
Let's look at some numbers and see.
For our purposes, we will assume a couple with a credit score of 700 and a mortgage amount of $200,000.
As of this writing, this couple could get a mortgage rate of 3.5% for a 30 year mortgage or 2.875% for a 15 year mortgage (assuming no points paid).
Crunching the numbers we get the following comparison:
15 Year Mortgage:
Monthly Payment = $1,369
Total Interest Paid Over 15 Years = $46,451
30 Year Mortgage:
Monthly Payment = $898
Total Interest Paid Over 30 Years = $123,312
So, if you can afford the extra $471 per month it seems to be a no-brainer to pick the 15 year loan, pay off your mortgage 15 years earlier and save $76,861 (probably more than this as you could invest that money). I am also ignoring the tax breaks you get with mortgage interest to make this example easier.
However, there a couple of reasons that make the 30 year mortgage attractive:
1. Your monthly payments are smaller and if you have a tough month financially or lose your job, you may struggle to make the 15 year payment. And you could make extra principal payments if you're able to, and it will payoff your loan quicker, giving you a lot of flexibility.
2. You can invest the amount you save with the 30 year mortgage each month. In the example above, if you saved $471 per month you would have $136,976 at the end of 15 years, assuming an average return of 6% or $194,500 with an average return of 10% (ignoring taxes).
This could be enough to payoff the mortgage in full at the end of 15 years, while still giving you the flexibility of a lower monthly payment if you should need it.
We don't know how much longer we will have low mortgage rates where we can borrow at 3% and earn (potentially) 5% or more. So, consider refinancing for 30 years and saving the difference and paying off your mortgage in 15 years with your savings.