Should you do a cash out refinance of a 30 year loan into a 15 year loan?

By Harry Jensen, Trusted Mortgage Expert with 45+ Years of Experience

Edited by Michael Jensen, Mortgage and Finance Guru

Updated October 20, 2020

In most cases it makes financial sense to refinance a longer term mortgage, such as a 30 year loan, with a shorter term mortgage, such as a 15 year loan. Reducing the length of your loan when you do a cash out refinance usually enables you to lower your mortgage rate and significantly reduce your total interest expense.  For example, the rate on a 15 year mortgage is usually 0.375% to 0.750% lower than the rate on a comparable 30 year loan. 

The challenge with refinancing into a shorter term mortgage is that the monthly payment is usually higher than the payment for a mortgage with a longer term. For example, the payment on a $300,000 30 year fixed rate mortgage with a 3.500% rate is $1,347 as compared to a payment of $2,054 for a 15 year fixed rate mortgage with a 2.875% rate.

Despite having a lower mortgage rate, the payment on the 15 year loan is higher because you repay the mortgage over a shorter period of time. Although your monthly payment is higher, you save a significant amount of money in the long run because you have so many fewer payments.

For example, the total interest expense for a $300,000 30 year loan with a 3.500% rate is $184,967 as compared to $69,677 in total interest expense for a 15 year loan with a 2.875% rate. A 30 year mortgage has 360 monthly payments whereas a 15 year loan only has 180 payments which explains why your interest cost is so much lower with a shorter mortgage.

The question you need to determine if you are considering refinancing a 30 year mortgage with a 15 year mortgage is can you afford to potentially higher monthly payment. While the long-term cost savings are significant, you need to make sure that the payment fits within your monthly budget.

One way to offset the higher payment is to use the proceeds from a cash out refinance to pay off other debt. If you can pay off or pay down a credit card, personal loan or car loan when you refinance, you may be able to lower your total monthly debt payments.

For example, if your monthly mortgage payment increases from $2,000 to $2,300 when you refinance into a shorter loan but you can use the loan proceeds to pay off a credit card account with a $400 monthly payment, then you actually reduce your overall debt expense by $100. In this scenario you have improved your monthly financial position and you are also saving money over the long term because your new mortgage is shorter.

The key to paying down debt when you do a cash out refinance is to make sure you have enough equity in your home. You need to pay off any existing mortgage and loans on the property before you can use the loan proceeds for other purposes. This can be challenging because lenders limit your mortgage amount you are eligible for with a cash out refinance.

Use ourCASH OUT REFINANCE CALCULATORto determine how much cash you can take out depending on the equity in your home

The maximum loan-to-value (LTV) ratio for a cash out refinance of a one unit property is 80% and 75% for a two-to-four unit property that you live in. So if you are doing a cash out refinance on a home or other single family property that appraises at $200,000 your maximum mortgage amount is $160,000 ($200,000 * 80% LTV ratio = $160,000 loan amount).

If you have a high mortgage balance or other loans on your property such as a home equity loan or HELOC, you may not receive sufficient proceeds from the cash out refinance to pay off or down the debt you want. In this case, it still may make sense to refinance into a shorter mortgage with a lower interest rate but you need to be financially comfortable paying a higher monthly mortgage payment and total debt expense.

We should also highlight that the mortgage rate for a cash out refinance is moderately higher than the rate for a refinance when you receive no proceeds from the loan -- also called a rate and term refinance. The rate should still be lower than for a longer mortgage but this is an important point to keep in mind.

The table below shows refinance rates and fees for leading lenders in your area. We recommend that you shop several lenders to confirm the terms for a cash out refinance. Comparing proposals from multiple lenders is also the best way to save money on your mortgage.

Sources

“Loan term.”  CFPB.  Consumer Financial Protection Bureau, 2017.  Web.

"B2-1.3-03, Cash-Out Refinance Transactions."  Selling Guide: Fannie Mae Single Family.  Fannie Mae, July 3 2019.  Web.