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Mortgage Refinance to a Shorter-Term Can Save You Money

Written By:
August 27, 2012 at 11:28 PM

According to a Freddie Mac report on mortgage applications, completed for the first quarter of 2012, nearly a third of borrowers or 31% refinanced into 15-year or 20-year fixed-rate mortgages instead of the conventional 30-year loan product. This level represents the second highest since 2002. At that time, 35 percent of homeowners selected short-term mortgages.

In 1992, a record 42 percent of borrowers refinance into shorter-term home loans.

The chief economist of Freddie, Frank Nothaft attributes the climbing percentage to “historically low rates and average three-quarters of a percentage point difference between 30- and 15-year mortgage fixed-rate mortgages.”

Many homeowners who are thinking of refinancing their mortgages to take advantage of low interest rates may find it to their advantage to refinance from a 30-year, 20-year, or 15-year fixed-rate mortgages.

This product may offer special advantages to homeowners who are baby boomers in their 50’s and 60’s. Borrowers will have to keep the home for least the next 18 months, which covers the closing costs.

Other Shorter-term Mortgage Products

Most homeowners focus on getting the lowest interest rate when refinancing their mortgages or getting a 15-year or 20-year loan. However, many borrowers would be surprised to learn they can obtain shorter-term loans with other durations, which better fit their personal circumstances. For example, borrowers can ask lenders for mortgages with the terms of a 15-year fixed-rate loan but with a shorter duration between 8 to 12 years.

Borrowers can take a similar approach with 30-year mortgage products – seeking durations of 20 to 29 years.

Shorter-Term Mortgages and Interest Deduction

Borrowers can realize several advantages from refinancing into lower rate mortgages with shorter-terms depending on their financial objectives. These products will not save borrowers much money on monthly payments. Nonetheless, homeowners will save money on the amount of interest paid for on their mortgages. This allows homeowners to build home equity at a faster pace.

For some homeowners, another advantage of refinancing into a shorter –term loan is the tax break. Homeowners, in the last few years of a 30-year fixed-rate home mortgage, can obtain a new mortgage, which increases the allowable mortgage interest rate deduction on their tax returns.

Sometimes, a shorter mortgage can reduce the allowable mortgage interest deduction, based on the loan amount. It does allow homeowners to accumulate equity faster, but with the trade-off of a smaller deduction.

The actual dollar amount of the mortgage interest rate deduction depends on the borrower’s tax bracket. Borrowers in the 15% tax bracket will save 15 cents for each dollar of deduction. A family in the 35% brackets receives a 35% deduction for each dollar of interest paid.

Compare Mortgages Side-by-Side

Homeowners who want to view the figures for two loan products can use our Mortgage Comparison Calculator to compare two loans and find out which one is better..

For example, a $350,000 15-year fixed-rate mortgage carrying a mortgage interest rate of 4.75% would have a monthly mortgage payment of $2,398.56. The same product with 10-year duration increases monthly payments to $3,361.88. However, the homeowner would save $28,315.21 in interest payments by shaving 5 years off the term of the loan.

As the above example shows, some borrowers will need to have the financial resources to afford the hefty difference in monthly mortgage payment for shorter-term mortgages. However, a 30- year fixed rate mortgage, which currently has an average interest rate of 3.66 %, can lower the monthly payment to $1,603.08.

Reducing the mortgage duration to a shorter duration of 20 years, at the same terms, increases mortgage payments to $2,058.75 per month. In this example, the borrower saves $83,008.92 by reducing the term by 10 years.

Our mortgage points calculator can help you determine the effects of points when refinancing your loan.

Borrowers who lower their monthly mortgage payment by refinancing their mortgages should take advantage of the savings by increasing contributions to their retirement plans or use the money to pay off other debts.





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