A growing number of homeowners are choosing to pay down their mortgages at a faster rate –even if it means a substantial jump in their monthly mortgage payments. In the first six months of 2011, 26% of homeowners who refinanced chose a 15-year fixed-rate mortgage, according to data from CoreLogic, a provider of financial, property and consumer information. During all of 2009, 18.5% of borrowers who refinanced opted for a 15-year term and a little over 9% of homeowners did so back in 2007.
The main factor that is prompting the shift to shorter loan terms is the historically low interest rates we’ve seen for fixed-rate mortgages. Homeowners are doing the math and realizing that rates have fallen enough that the increase in payment between a new 15-year mortgage and their current loan is no longer unbearable for their budgets. The people taking advantage of the 15 year term mortgage are typically with the best credit and the most equity, therefore most suited for a shorter-term loan.
Homeowners seem to really be working hard to pay off their mortgages, so they’re more readily able to take on a higher payment and work toward paying their mortgage debt down. This also acts as somewhat of a forced savings account for homeowners, given that the higher payments help pay down the principal at a quicker pace.
It also seems that now more than ever, homeowners are ready to pay off their mortgage. This is a huge shift in borrower thinking, as it has been common practice to take out the biggest mortgage that you could and use all of the money you would have otherwise had in the house and put it into stocks and bonds. This is a way of thinking of your house and mortgage as part of your entire investment portfolio. That worked well for professionals in investment finance, but for the average person, debt is a just another added stress to their lives as well as their overall budget. In turn, many Americans have reverted to the goal of paying off their house and getting rid of their mortgage.
However, refinancing into a shorter-term mortgage isn’t a strategy for everyone. Again, choosing a shorter term usually means you’ll get a better rate—and you’ll pay much less interest over the life of the loan—but a shorter timeframe ramps up monthly mortgage payments.
For example, with a 4.5% interest rate on a 30-year fixed-rate mortgage of $200,000, you would have a monthly payment of about $1,015, including principal and interest. The monthly payment jumps to about $1,480 with a 4% interest rate on a 15-year fixed-rate loan. Of course, if the refinancing borrower’s current 30-year loan has a higher rate, the difference between the monthly payments could be less. Still, you should count on some increase in monthly payments. In terms of interest alone, the total interest paid on the life of that 30-year fixed loan is almost $165,000, whereas with a 15-year term, your total interest paid would be much less, around $75,000.
In general, those who choose 15-year fixed-rate mortgages are older and have more equity and less debt than others do. They also earn higher incomes and don’t have some of the added expenses that younger homeowners typically do. If you’re thinking of taking on a 15-year fixed-rate mortgage, here are some tips on what you should have in place to make things easier:
-A plan to stay in your home for an extended period of time
-Substantial savings, including at least a year’s worth of living expenses in liquid accounts
-A debt-to-income ratio below 35%. So if you have a gross salary of $5,700 per month, for instance, your monthly debt – including any mortgage payments, taxes, insurance, homeowners-association dues as well as auto and student loans and credit-card debt –would have to be a max of $1,995 to get a 35% ratio.
Borrowers who don’t meet those standards, or are worried about future loss of income might be better served taking a longer-term mortgage but making extra payments to the principal to pay off the loan faster. A 30-year mortgage provides more flexibility for those who need it. Switching loan terms is a big decision, and it’s important to weigh all the pros and cons and take a good look at your finances and future plans before doing anything.