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When does it make sense to refinance to a shorter loan?

Posted by  on Feb 13, 2017
 

Q: I'm ten years into paying off a 30-year mortgage. I want to refinance, but I feel like I'm stuck in the middle. I haven't quite gotten to the 15-year mark, but if I refinance to another 30-year mortgage I'll feel like I'm just starting the whole thing over again. At what point does it make sense to refinance to a shorter mortgage?

A: There are three important elements to determine mortgage loan refinance timing:

  1. Rate comparison. If your mortgage is about ten years old, you might save substantially on interest no matter which mortgage term you choose. Thirty-year mortgage rates were nearly three full percentage points lower in the winter of 2017 than the winter of 2007. However, 15-year rates are cheaper still - recently they were about 70 basis points lower than 30-year rates. The wider the spread between 15 and 30-year loan rates, the more incentive there can be to go with a shorter loan.
  2. Monthly payment affordability. A shorter loan term compresses the repayment period, resulting in higher monthly payments than a longer loan. However, since you are already 10 years into your 30-year mortgage, you might not find the shift to a 15-year loan all that drastic. In fact, the impact on monthly payments of the shorter term might be completely offset by the lower interest rate.
  3. Your current balance. Mortgages have become more straightforward since the housing crisis, but ten years ago you may have gotten a mortgage with low principal payments in the initial years. The more you have left to repay, the more burdensome a switch to a shorter mortgage may be.

Finally, while 15 and 30-year mortgages are the most common, depending on your lender you might be able to get a loan for a term that more precisely meets your needs. However, if you can swing the monthly payments, switching to a shorter repayment period is generally the best way to minimize your interest expense going forward.

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