Higher home values and low mortgage interest rates have many homeowners consider refinancing their mortgages. In additional more borrowers are choosing loan products with shorter terms. This presents a viable option for homeowners who want to save more money on the mortgage over the long-run.
Borrowers who have a high-interest rate and can refinance to a significantly lower rate, may be able to avoid higher monthly mortgage payments. However, many people who refinance to a loan with a shorter payback period will end up with higher payments.
To determine if a loan with a shorter term is right for you, take into account the following factors as they relate to your situation:
Build up equity faster
This home refinance option helps homeowners build up equity quicker—since a larger portion of the monthly mortgage payment will be applied to the loan’s principal. More significantly, the borrower pays less interest throughout the term of the mortgage.
A faster payoff of the mortgage give a homeowner the flexibility to sell the property later without consideration for a mortgage or increase cash flow as they get closer to retirement. The money saved on monthly mortgage payment can help finance their retirement lifestyle or fund investments.
With the stricter income requirements by lending underwriters, borrowers need to have a steady and reliable cash flow. People who have some extra disposable income have a better chance of qualifying for short term mortgage because the mortgage payment may increase. The higher monthly payment will require the borrower to have a higher debt to income ratio.
Most mortgage experts agree that the homeowners who make the best applicants for refinancing into short-term mortgage products have an existing mortgage with an interest rate of 4% or higher. Furthermore, these people have not refinanced their mortgages within the last six months.
Length of time in home
The borrower must figure out how long they plan to live in the home. For a person who intends to reside in the home for only a few years, the cost of refinancing the mortgage may exceed any benefits. If the person calculates that it will take four years to recoup the mortgage refinancing expenses but plans to relocate in year three, it’s not worthwhile to refinance the loan.
Selecting a term
The most common chosen by borrowers are mortgages with increments of 15 years. Some banks offer 20-year or 18-year terms for mortgages. Borrowers need to shop around and compare terms and the cost of refinancing. Some mortgage lenders may be receptive to other terms as well—just ask.
Besides making sure the new loan is affordable, take the time to accurately calculate the costs to refinance the mortgage, including application fee, loan origination fee, points, and appraisal.
The refinancing cost can vary from 3% to 6% of the loan amount. Make sure your computation includes the prepayment penalty for paying off the mortgage early. If you refinance with the same lender, request the bank to waive this fee if it applies to your loan.
Taking advantage of low interest rates to refinance your mortgage into a new loan with a shorter period is worth considering. Perform the necessary calculations and determine if you will realize some hefty savings—at the least break even. Keep in mind that this mortgage refinancing option is only intended for individuals who can afford the choice of making a higher monthly mortgage payment if necessary to secure the loan.