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Should You Refinance to a Shorter-Term Mortgage?
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Homeowners who want to pay off their mortgage sooner and save on lifetime interest costs might be able to achieve both goals with a refinance to a shorter-term mortgage. However, be prepared for the shock of a larger monthly payment if you take out a new short-term mortgage.
On the flip side, the longer the loan term, the smaller the monthly payments, but the more you’ll pay in interest over your loan’s lifetime.
When does it make sense to refinance to a shorter-term mortgage?
If your goal is to pay the least amount of loan interest as possible, or to get rid of your mortgage much sooner, you may find it beneficial to refinance to a shorter-term mortgage. Your monthly mortgage payment will be higher, but you’ll save money over time. You’ll likely also benefit from a lower interest rate by choosing a short-term mortgage.
Let’s consider an example of a borrower’s refinance to a 15-year mortgage. Their existing loan has a 30-year repayment term and 3% interest rate.
|Existing 30-year loan||Refinanced 15-year loan|
|Total interest cost||$103,554.90||$35,830.52|
The table above shows that refinancing to a 15-year loan makes your monthly payment jump by about $467, but the tradeoff is your total interest cost will be more than $67,700 lower than a 30-year mortgage.
Pros and cons of refinancing to a shorter-term loan
| You’ll build home equity faster
You’ll pay less interest over the life of your loan
You’ll have a lower interest rate compared to a longer-term loan
| You’re locked into a higher mortgage payment
You’ll have less wiggle room in your monthly budget
You may have a harder time qualifying, depending on your income
When does it make sense to refinance into a longer-term mortgage?
A longer-term mortgage may make more sense if shrinking your monthly payment is your primary goal. You’re trading the higher monthly payment of a short-term mortgage for a more expensive loan, though.
Revisiting the earlier example, the 30-year mortgage had a total interest cost that was nearly three times the interest charged on the 15-year loan — $103,554.90 versus $35,830.52.
Pros and cons of refinancing to a longer-term loan
| You’ll have a lower monthly payment
You may get a lower interest rate compared to your current rate
You might have room in your budget for extra principal payments
| You’ll have a higher interest rate
You’ll pay more in interest over the life of your loan
You’ll build home equity at a slower pace
Should I refinance or pay extra?
Deciding whether to refinance to a shorter-term mortgage ultimately depends on what’s most comfortable for your situation. Before you move forward, factor in the following considerations.
Do you plan to move anytime soon?
LendingTree’s refinance calculator can help you estimate your break-even point, as well as your lifetime interest savings.
Can your budget handle a higher mortgage payment?
Shorter loan terms may come with a lower interest rate, but that won’t do you any good if you can’t afford the mortgage payment. An unexpected illness, job loss or other financial setback could make your payments unaffordable and put you at risk of mortgage default.
You can’t predict the future, of course, but it’s wise to have a backup plan for these scenarios, such as a larger emergency fund.
Are you prepared for the tax implications of a short-term mortgage?
Homeownership comes with many benefits, including tax incentives. These include the mortgage interest deduction, which allows you to deduct your loan interest payments from your taxable income each year.
Since you’ll pay significantly less interest with a shorter loan term, you won’t be able to deduct as much interest as a borrower with a longer repayment term. Consult your tax professional for more guidance.
Alternatives to refinancing to a short-term mortgage
- Make biweekly payments. Divide your payment amount by two and make biweekly mortgage payments. Over the course of a year, you’ll have made 26 half payments, or 13 full payments. Sticking to this schedule can shorten your loan term by a few years.
- Request a mortgage recast. If you have a lump sum set aside that you’d like to put toward your mortgage balance, ask your lender about recasting your mortgage. You’d shrink your outstanding balance and end up paying less each month, since your lender recalculates your mortgage payments based on a smaller principal amount.
- Earn extra income to pay down your loan balance. Use some of your free time to pick up a part-time gig or side hustle. Your earnings can help you chip away at your loan’s principal balance more quickly.