Should You Refinance to a Shorter Term Mortgage?
Wouldn’t it be nice to pay off your mortgage sooner? You would save on interest and enjoy peace of mind with one less monthly bill to worry about. Refinancing to a shorter term mortgage sounds like a dream come true, but it’s not right for everyone.
Mortgages are typically issued in 15 or 30-year terms. 30-year mortgages are more common, because buyers get a lower monthly payment. This is appealing, because it usually enables you to buy a more expensive home. However, by refinancing to a shorter term mortgage, you could potentially save a lot of money on interest.
If you’re making more money than you were when you initially purchased your home or you’d like to take advantage of the currently low interest rate, refinancing to a 15-year mortgage may be a great strategy. Learn more about the pros and cons of refinancing to a shorter term mortgage to help determine if it’s right for you.
Pros of Refinancing to a Shorter Term Mortgage
There are many upsides to a shorter term mortgage. By paying off your mortgage faster, you’ll build equity faster and pay less in interest. Essentially, you will own your home sooner. How much could you save? That depends on your interest rate and how many years are left in the life of your loan.
For example, let’s consider a $200,000 fixed-rate mortgage with an interest rate of 4%. If you take 30 years to pay the loan, you will pay $143,000 in interest alone. If you pay the same loan in 15 years, you would pay around $66,000 in interest. This is ignoring the fact that shorter term mortgages often come with lower interest rates, too.
However, your monthly payment would be higher. For the 15-year mortgage, you’d pay about $1,479 per month. With a 30-year term, you’d pay just $954 per month. It’s important to remember that the near-historically low interest rates we’re seeing in today’s market change this rule. If you refinance to a shorter term mortgage today, you may not even see significantly higher monthly payments.
The average interest rate today for a 15-year fixed-rate mortgage is about 2.4%. Using the example mortgage above, you’d pay about $1,324 per month. That’s only $370 more per month than the 30-year fixed, which may be affordable depending on how your financial status has progressed since you originally obtained your loan. If you’re able to increase your monthly payment a bit without significantly stretching your budget, now is the time to do so.
Cons of Refinancing to a Shorter Term Mortgage
A shorter term mortgage sounds like the obvious choice, but it’s not feasible for everyone. As explained in the example above, the monthly mortgage payment may double, which isn’t affordable for everyone. When you’re locked into a higher monthly payment, you have less money available for other expenses or investments. You have less wiggle room in your budget. This could result in being forced to take on other loans with higher interest rates, like credit card debt, in the event of an emergency. Rather than taking the risk of committing to a higher monthly payment, it may be wise to contribute that money to a 401(k) or IRA account.
Because 15-year mortgages aren’t right for everyone, they may be difficult to qualify for. Lenders are even more strict about borrowers having a great credit score and proven monthly income than they would be with a 30-year mortgage. Shorter mortgage terms also reduce your ability to claim mortgage interest tax deductions, which deduct your loan interest payments from your taxable income each year. Since you’re paying less interest, you will qualify for lower deductions. This is unlikely to cancel out the interest savings, but it’s another factor to consider.
Is Refinancing to a Shorter Term Mortgage Right for You?
If a shorter term mortgage is affordable for you, it may be a financially sound choice. This is especially true with the incredibly low interest rates we are currently seeing. In fact, interest rates are so low that many homeowners may be able to refinance to a 15-year term without significantly increasing their monthly payment. If you have had a life change, like an inheritance or a major promotion, it could be a great time to refinance to a shorter term mortgage.
It’s important to run a direct comparison between what you are paying now and what you would pay with your new mortgage terms. Your lender can help you do so, or you can use an online calculator to run a few examples. When calculating the financial benefits of refinancing, be sure to consider closing costs and any changes to tax deductions.
If you don’t think you’ll qualify, or a 15-year term simply isn’t affordable for you, there are other options. You can change up your payment schedule to slightly increase the number of payments you are making each year. If you have unexpected income or have set aside money, ask your lender about recasting. Your mortgage can be recalculated based on a smaller principal amount. This may be a more accessible way to set aside money on your own and reduce your monthly mortgage cost without committing to a higher payment by shortening your term.
Research your options and speak to a few lenders to decide if refinancing to a shorter term mortgage is the right choice for you.
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