It's pretty obvious when you think about it: the longer you borrow money, the higher your borrowing costs are likely to be. Take out a personal loan or auto loan for four years, and you should pay less each month than you would on a two-year one. But, by the time you make your last payment, you'll almost certainly have parted with more money overall.
Why refinance for a shorter term?The same applies to home loans -- but on a much bigger scale. Chances are, you can easily save tens of thousands of dollars over the lifetime of yours if you reduce its term when you refinance your mortgage. And yet surprisingly few do.
Last month, LendingTree published the results of a survey, commissioned at the end of last year, of homeowners who had recently refinanced. The poll found that, in 2012:
- Over 69 percent of respondents had refinanced into a 30-year fixed-rate mortgage (FRM).
- Just 13 percent had opted for a 15-year FRM.
- An even smaller 9.5 percent had chosen a 20-year FRM.
Best refinance rates even better for shorter-term mortgagesIn a press release, LendingTree went on to give examples of the potential savings the majority had missed out on. They're based on the assumption that someone with a $250,000, 30-year FRM, with a 5.5 percent rate, refinanced in Dec. 2012. The calculations reflect the lower rates that shorter-term loans generally attract:
- Having a new 30-year FRM at 3.46 percent, their monthly payment would drop by $302, and they'd save $107,372 in interest compared with their old mortgage.
- Having a 20-year FRM at 3.37 percent, their monthly payment would rise by $14, but they'd save $167,030 in total interest compared with their old mortgage.
- Having a 15-year FRM at 2.86 percent, their monthly payment would rise by $291, but they'd save $203,054 in total interest compared with their old mortgage.
Shorter-term refinances are not as popular among borrowers as they should be... Loans with earlier payoffs carry less risk for lenders, and often result in lower interest rates for the borrower...
Borrowers should explore all loan options to determine which loan best suits their short term and future financial goals. A good rule of thumb is to refinance at a term equal to or less than your current term, if possible and affordable for the borrower.
Best Refinance Deal Is the One that Suits YouDoug Lebda made an excellent point in urging borrowers to consider their future financial goals when asking themselves: Should I refinance?
If you looked closely at the three examples above, you'll have noticed that cutting your loan term often -- though by no means always -- involves increasing your monthly payments. In other words, you could have to endure some short-term pain in order to make that long-term gain.
Is it worth it? Only you can decide. But if you're at a point in your life when you're struggling to make ends meet (maybe you're bringing up a young family or recovering from a financial setback) then few would blame you for opting for the lowest possible monthly payment.
If, on the other hand, you're 10 or 15 years from retirement, then taking advantage of current ultra-low refinance rates on shorter-term loans could transform your golden years. And the prospect of being free of a mortgage at or close to the time you quit work could be well worth some belt-tightening now.