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How to Refinance Your Mortgage to Shorten Payment Terms

A 30-year term may be the standard for mortgages today, but it is far from the only option available. Refinancing into a fixed-rate 20-, 15-, or even 10-year term can be hugely advantageous, depending on what you are hoping to achieve. Typically, interest rates go down along with the length of the mortgage term; so a 30-year will tend to carry a higher interest rate than a 15-year loan.

The trade-off is that you pay a higher total rate, making the shorter term more expensive to cover each month. You are paying more toward the principal with each payment, so while the interest is low, the installments are higher. Whether this makes sense for you depends, as always, on what you can afford, as well as what your financial goals are.

Maybe you are preparing for retirement. Maybe you just want to own your home sooner, and gain equity faster. Maybe you can afford a slightly higher monthly payment, and want to free up your money to invest (or enjoy!). Maybe you just want to change the balance of your payments so the interest doesn’t have so much of your monthly check all spoken for in advance.

How It Helps:

  • Pay Less Interest

General wisdom holds that you should aim for the shortest mortgage term you can afford, because that minimizes your interest burden. If you originally purchased a 30-year mortgage, but now can afford higher payments, then refinancing could save you a significant amount of interest. Besides potentially getting a better rate than you did on the 30-year mortgage, a shorter repayment term leaves less time for interest to accrue, all of which means more savings for you.

  • More to Principal Earlier

The more you pay toward your principal, the lower your interest burden becomes. But the benefits aren’t just in money saved--every dollar you put toward your principal balance is a dollar of equity you own in your home. In a 30-year mortgage, it can take years before you make any substantial contribution toward your principal, because all the interest is front-loaded. That means you may live in your house, but the equity still belongs to your lender. Having more equity in your home also gives you greater leverage in case you want to get a new loan, or a Home Equity Line of Credit.

  • Downsize Debt Sooner

Financial experts agree: one of the biggest mistakes retirees can make is to retire with debt. Going on a fixed income can be a major challenge even with proper planning, and for most people the largest debt obligation they ever have is their home mortgage. Whether you are anticipating more medical bills, hope to travel, or just want to protect your nest egg, eliminating debt may start with your mortgage. Refinancing into a shorter term mortgage can help you pay off your home sooner, before you find yourself on a fixed income. Besides protecting your other investments for your retirement, you can rest assured that you won’t be leaving any debts for your family to take care of when you are gone.

What to Look For:

You will want to carefully select the shortest term that you can afford. Once you get locked in at the new rate and schedule, you are committed, which could mean giving up some flexibility. Ideally, you will get a lower rate than your current mortgage, so it won’t be as challenging to make up the difference in your monthly payments. Key considerations for you include:

  • What total monthly payment can you afford (including insurance and taxes)?

  • How long do you plan to stay in your home?

  • How much do you have left to repay on your current loan?

  • Can you afford to lose some or all of the Mortgage Interest Tax Deduction?

Watch Out: If your goal is to pay your mortgage off early, you have multiple options. If you come into a windfall like an inheritance, winning the lottery, or just earning a bonus at work, it might be better to simply pay a little extra on your current mortgage while you can. This can help cut the total interest, as well as bringing you closer to owning your home outright, but without the obligation to continue making higher payments every month. That flexibility may have its own value for you.

Likewise, if you only have a few years left on your mortgage, you are likely already paying more in principal than interest, and may just want to stay the course. Refinancing is partly a matter of timing, planning, and evaluating your goals. It is a powerful tool, capable of providing incredible savings if you use it at the right time and don’t wait too long to see if it helps in your situation.

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