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When you refinance from a 30-year fixed-rate mortgage to a 15-year home loan, you pay a lower interest rate and save a lot in interest payments. But a 15-year mortgage has two major drawbacks compared with a 30-year loan for the same amount:

  • The monthly payments are higher.
  • You have less flexibility when money is tight, which can happen when you have unexpected expenses or a surprise drop in your income, whether temporary or permanent.

If you’re thinking about refinancing, be sure to compare refinance rates.

Money in the bank will pay the bills; home equity will not.

What flexibility means

With a 15-year mortgage, your minimum monthly payment is just that — a minimum. The monthly payment doesn’t go down when you’re short of money. The same is true for a 30-year loan, but that minimum monthly payment is lower than it is for a 15-year mortgage.

But a mortgage lets you pay more than the minimum payment every month. This means you can get a 30-year mortgage and make extra payments each month to pay off the loan more quickly. You can even make your payments big enough to pay off the mortgage in 15 years. There’s a trade-off: You’ll pay a higher interest rate on a 30-year mortgage versus a 15-year loan. Compare mortgage rates on 30-year and 15-year mortgages.

In the scenario below, you could get a $200,000, 30-year loan and pay it off in 15 years by adding $530 to each monthly payment. This gives you the flexibility of withholding that extra $530 when times are hard. Example: Your kids’ college tuition is due, and then the car breaks down.

Adding payments to cut loan term in half
Interest rate Monthly principal and interest Total interest, life of the loan
30-year loan for $200,000, paid off in 30 years 3.625% $912 $128,366
30-year loan for $200,000, paid off in 15 years 3.625% $1,442 $59,572
15-year loan for $200,000, paid off in 15 years 2.875% $1,369 $46,451

To calculate the effect of making extra payments (each month, annually or one time), try Bankrate’s mortgage amortization calculator. Input the loan amount, term and interest rate, then click the “show amortization schedule” button, which reveals a section that lets you calculate what happens when you pay extra.

Savings before early payoff

There’s another downside to paying off a mortgage in 15 years instead of 30 years: You could save that extra money for retirement (or for emergency savings) instead of plowing it into your home’s equity.

“I’d much rather have people have the money in their 401(k) rather than wrapped up in their house,” says Greg McBride, CFA, senior vice president and chief financial analyst for Bankrate. “Money in the bank will pay the bills; home equity will not.”

It’s wiser to pay off high-interest rate debt first — and a typical mortgage carries a low interest rate. Along with paying off high interest rate debt, McBride advises saving for emergencies and for retirement. Instead of paying off the mortgage early, he says, “preserve the financial flexibility to fully fund things like your tax-advantaged retirement savings accounts.”

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