Is a shorter-term mortgage right for you?
You may pay off your home loan quicker, but you'll also pay more per month. Here's a look at the pros and cons of this practice.
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Melissa and Jeff Joy got a pleasant surprise in January when their Dexter, Mich., home was appraised for a refinance: Its value had grown to $235,000 from $225,000 when they purchased it in 2010. That's no small thing in a state where home values are down 25%, on average, from 2007.
Then they got more good news: By adding $300 to their monthly mortgage payment, they could pay off the loan twice as fast, in 15 years instead of 30. They jumped at the chance to get rid of house payments in 2027, just when they'll need to start paying their son's college tuition. (Bing: Just how low are mortgage rates right now?)
When the Joys bought their home, their 5.25% interest rate seemed an excellent deal for a 30-year, fixed-rate loan. They knew they'd end up paying $144,000 in interest if they kept the home 30 years. But that's how mortgages work: The longer your loan term, the lower your monthly payments — but the more you pay in total interest.
Unheard-of low interest rates make this a remarkable moment for homeowners to shorten their mortgage terms, at least if they can qualify for a refinance and can afford a larger payment.
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Here are benefits and drawbacks to refinancing your mortgage to a shorter term.
- Own your home outright faster. You'll be free of mortgage payments sooner, too. You still must pay taxes and insurance, though.
- Save on interest. The savings are potentially massive. Melissa Joy, a certified financial planner and co-owner of The Center for Financial Planning in Southfield, Mich., says she and her husband will save a whopping $128,190 in interest if they keep the new mortgage with its 3.375% interest rate for the entire 15 years.
- Equity builds faster. "It was noticeable right off the bat" says Melissa Joy, who sees equity piling up quicker on her monthly mortgage statements. Even if the Joys sell their home before the new mortgage is paid, they'll pocket more cash from the sale than they would have with the old mortgage.
For example, if the Joys had borrowed $200,000 over 30 years at 5.25% and sold their home in the 10th year of the loan, they would have accumulated $38,424 in equity from their payments. But by borrowing the same amount over 15 years at their new rate of 3.375%, they'll have roughly $129,000 in equity after 10 years.
- On our blog, 'Listed': 10% of mortgage mods reduced principal
- You may not qualify. You'll need a strong mortgage application to satisfy lenders, and your home's appraisal must be high enough to support your loan request. That could be a problem if you have low or negative equity.
- Your payment may grow. Depending on the fees, the size and term of your loan, and the difference between your old and new interest rates, your new monthly payment is likely to be higher, maybe much higher. Or it could remain the same. The Joys' payment grew from $900 a month to $1,250.
- It's expensive. Fees of $5,000 or more could wipe out any benefit to refinancing. These charges may include an appraisal fee, inspection fee, private mortgage insurance, prepaid interest, application fee, loan origination fee, homeowners insurance, and points and fees imposed by the Federal Housing Administration or other government lending programs. The Federal Reserve's Consumer Guide to Mortgage Settlement Costs explains mortgage fees and estimates costs.
- The paperwork is a headache. Lenders may demand a lot of documents, from tax statements to old divorce papers. It can seem invasive.
- It takes months. Lenders are so busy now, and their lending requirements are so strict, that it can take months to get a loan approved. TD Bank, for example, averages 51 days to process a refinance from the time the application is submitted, says Michael Copley, executive vice president for retail lending at TD Bank. That's relatively quick. Some banks can take as long as 120 days. When choosing a lender, ask several about their turnaround times, Copley says.
If you take a $160,000 loan at 3.5%, at 30 year payment would be $718. Making an additional $200 payment will "save" you $34,911 and you will pay off the loan in 243 months.
If you instead take that $200 and invest in the market and get an 8% return, you can pull out your investment at 243 months, adjust for a capital gains tax of 15%, and pay off the loan in full and pocket an additional $33,047. Don't think you can get an 8% return? If you get 5% you still pocket $1649.
Result, don't pay off your loan early at the current interest rates, you are just throwing money away.
If you're young, have a secure long term income, and can save additional funds, a 20 yr or even
15 year mortage is a definite yes. Now that interest rates are low. When (if) the economy turns
around the rates will go up, so lock in your interest rate. If you're 25, and have a 15 year loan,
your paid up by 40. You can re-fi for a well deserved vacation or some kind of treat.
Make sure you save for a rainy day or you could undo all your efforts. The bigger monthly payments should make you cautious about unnecessary frills. Also, over the years your income
will likely improve, but be ever mindfull of the possibility of losing the income you've counted on.
Over time, save enough to cover all of your bills for ONE FULL YEAR. More often than not you
will be unemployed for a year before you get re employed at the level you desire.
if you cannot afford the long run how the hell you going to afford the short? our financial realism
it not a sport, we are commin g out far far short, we have let our system ruin us by their doin us"
and untill we unite with our futures in sight we shall fall further into greeds bitei, people frown
thinkingme a clown, but my truths one day to make us soundt fropwn
I would suggest most people start by contacting their existing lender to see if they can offer a better rate. I had a loan through Wells Fargo, and they offered me a lower rate with no points/closing costs because I was a good customer. They did the same for my neighbor. If you are a good payer, they will want to keep you as a customer and will likely help you out.
Of course, if you are a dead-beat and missed a few payments, you are out of luck.