Doing the Math
Refinancing into a shorter-term mortgage isn't a strategy for everyone, however, 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 time frame 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 $1,015, including principal and interest, Cutts said. 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 general, Walters said, those who choose 15-year fixed-rate mortgages are older and have more equity and less debt than other folks. They also earn higher incomes and don't have some of the added expenses that younger homeowners typically do.
"People who are taking these loans are financially stable and can afford the payments, but at the same time are planning on staying in their home for an extended period of time," Thomsen said.
Walters said homeowners shouldn't take on a 15-year fixed-rate mortgage unless they have substantial savings, including at least a year's worth of living expenses in liquid accounts.
Also, he recommends having 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.
Make That Extra Payment
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, Walters said.
For instance, if you refinance a $200,000 mortgage into a 30-year loan with a 4.5% rate, and then apply $100 of the savings to the principal payment each month, you'd save $31,700 in interest over the life of the loan, Cutts said. And you would pay off the mortgage in 25 years, instead of 30, she said.
What's more, you would have the flexibility of not paying that $100 in months when money gets tight. "Maybe today you're feeling flush with money. Maybe you're worried in the future that income might change," Cutts said. With a 30-year mortgage, you have more flexibility. "Shortening to 15 years is a pretty big bump in payment."