The 20-year refinance solution

Posted by  on Sep 06, 2012

If eliminating your mortgage is one of your financial goals, you may have considered alternative mortgage loan terms for refinancing. For some homeowners, a 15-year mortgage loan works well because of the low interest rate; but for others, getting locked into higher mortgage payments may be daunting. An alternative that may work for you is a 20-year mortgage.

According to the Mortgage Bankers Association, 20-year mortgages are the third most popular mortgage term. They are particularly attractive to refinancing borrowers.

Advantages of a 20-year mortgage loan

While current mortgage rates are low and therefore mortgage loans are relatively more affordable, borrowers that pay attention to their comfort level may find their search leads to a more affordable solution. Mortgage rates on a 20-year loan are typically slightly lower than a 30-year fixed-rate loan and slightly higher than the average mortgage rates on a 15-year loan. The spread between these loans shifts daily, but recently a lender offered a 30-year fixed-rate loan at 4.00 percent, a 20-year loan at 3.875 percent, and a 15-year fixed rate loan at 3.372 percent. The payments for principal and interest on a $250,000 loan at those interest rates would be $1,194 for the 30-year loan, $1,499 for the 20-year mortgage loan, and $1,772 for the 15-year home loan.

The difference in monthly payments is, of course, even more significant for jumbo loan borrowers. For example, an $800,000 loan at those interest rates would generate a monthly principal and interest payment of $3,819 for a 30-year loan; $4,795 for a 20-year loan, and $5,669 for a 15-year loan -- a difference of $874 per month between the 15- and 20-year mortgages.

In addition to the difference in overall interest paid on the loan, refinancing into a 20-year term for homeowners who have had their 30-year mortgage for five to ten years means they would not have to extend their payments for yet another 30 years.

Qualifying for a 20-year mortgage loan

To qualify for a 20-year mortgage, you'll need to meet typical lender standards for a home refinance, such as credit score of 720 or 740 and above to be offered the best mortgage rates. In addition to documenting your income and assets, you will need to meet the lender's standards for your debt-to-income ratio, typically around 40 percent. Borrowers with compensating factors such as an excellent credit history or significant assets may be allowed a debt-to-income ratio of as much as 45 percent.

In order to refinance into a shorter loan term, you'll also need at least some home equity, often at least 5 percent. If you have less than 20 percent equity, you will need to pay private mortgage insurance which will increase your monthly payments.

If you are undecided about the appropriate loan term for your financial needs, you can consult with a lender who can give you a detailed assessment. Remember you can always make extra principal payments to pay off your mortgage faster even if you opt to refinance into a 30-year mortgage.

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