Refinance Into a Shorter Term

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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.

Apply for a Home Loan

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:

  1. Refinance a 30 year loan into a 30 year loan with a lower rate (save now)
  2. 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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