Posted by Refinancing into a shorter term (ex: 30 year to a 15 year loan) is often the most financially beneficial option when it come to refinancing. However, refinancing becomes a question of when do you want to save money – Now or Later? At first glance you might be saying NOW! Why wouldn’t that be the right answer? Let’s dig a little deeper to find out why that might be the WRONG answer.
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Lower Rate/Save Now Vs. Shorter Term/Save Later
Simplified, there are 2 main schools of thought when comparing lower your interest rate or shortening your loan term. Typically, they are as follows:
- Refinance a 30 year loan into a 30 year loan with a lower rate (save now)
- Refinance loan into a shorter term loan – ex: a 30 year loan into a 14 year term (save later)
*note shorter terms also typically offer a lower rate
When a borrower reduces their rate while staying in the same 30 year loan term they see a drop in their Arizona mortgage payment. However, when a borrower wants to find a way to save more money over the long-term on option #2 above is the way to go. Refinancing into a shorter term mortgage typically saves homeowners more money over the life of the loan compared to just lowering their interest rate while keeping the same 30 year term.
Refinance Into a 15 Year Home Loan
In order to show the true impact of a term reduction refinance, take a look at these 2 examples. Assume the following:
Hank the Homeowner
Current Mortgage Balance: $250,000
Current Mortgage Rate: 5.5% (APR 6.231%)
Current Mortgage Term: 30 Year Fixed
Current Monthly Payment (principal and interest): $1,419
OPTION 1 | Refinance into a 30 year loan with lower rate
Refinance Rate: 4.5% (APR 4.611%)
New Mortgage Balance: $248,000
New Loan Term: 30 Years
New Lower Monthly Payment (principal and interest): $1,266
Monthly Savings: $156
Total Principal and Interest payments over the life of the loan: $455,760
OPTION 2 | Refinance into shorter term (20 year loan) a lower rate
Refinance Rate: 4.125% (APR 4.377%)
New Mortgage Balance: $248,000
New Loan Term: 20 Years
New Monthly Payment (principal and interest): $1,531
Monthly Payment Difference compared to original loan: + $112
Total Principal and Interest payments over the life of the loan: $367,440
As you can see, over the life of the 20 year loan you would save $88,320 more than with the 30 year option. So ask yourself again – Now or Later? Do you want to save $112 per month now OR $88,320 later/over the next 20 years.
Tortoise and the Hare Mortgage?
Delayed gratification – not our society’s favorite concept. If you do not need additional cash flow now, cutting the term of a home loan may be a much better option. Paying a mortgage off years earlier by refinancing into a shorter term can save an Arizona homeowner thousands more than a rate reduction refinance. If you are refinancing, make sure to look at all your options and resist the urge to jump into a rate reduction refinance.
By Jeremy House
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