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Should You Refinance for a Shorter Term?


As interest rates are still at all-time lows, you're probably thinking about refinancing your mortgage. When you refinance for a shorter term, you save on interest and pay off your home sooner. Sounds good, but taking out more debt is never a simple proposition. Here are some considerations:

Can you afford a higher mortgage payment?

Squeezing an extra few hundred dollars out of your monthly budget and limiting access to ready cash can be a risk, for a few reasons.

  • Shorter-term loans mean lower interest rates, but they can come with substantially higher monthly payments.
  • Lenders will need to check your debt-to-income ratio to make sure you can afford to refinance. The ratio should be no more than 35%.
  • Will you be able to meet other financial goals? If you're not contributing to savings, putting more money into your home may not be an optimal long-term strategy. A better strategy might be a 529 college fund, a retirement account, a life insurance policy or other investments.
  • Do your calculations. Based on how far along you are with your repayments, refinancing may make a big change in your monthly payments or a small one. Use an online amortization calculator to run multiple scenarios.
  • Are you planning to move within the next few years? If so, refinancing might not save you money. Considering all the costs that go into refinancing, you may not make back the money you spent on fees before you move.

Non-refinancing options

You may be able to save without going through the effort and expense of refinancing. Check with your lender to see whether any of these options are available to you:

  • Instead of refinancing, take your current payment, divide it by 12 and then add that amount to your monthly payment. Make sure the extra amount goes to principal, not interest. If you make these additional payments consistently, you could knock years off your 30-year mortgage.
  • Go biweekly. Pay your mortgage every two weeks, giving you the equivalent of a 13th payment. Some lenders welcome biweekly schedules. However, be wary of setup fees or using a third-party servicer that can diminish your savings.
  • Crunch the numbers to find out the monthly payments on a shorter-term loan, then make those payments each month without going through refinancing. That way, if you're short on cash some months, you can pay your standard payment with no penalty.

While refinancing can lower your monthly payment, it can also add extra years to the total amount of time you'll be financing your home. Contributing to a retirement plan or beefing up emergency savings funds can help you avoid incurring more debt. Investing the extra money may earn a higher rate of return. Consult with your lender and a qualified financial professional to figure out what's best for you.

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The information provided in this email newsletter is for general guidance only, and does not constitute the provision of legal advice, tax and accounting advice, real estate investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional real estate, tax, accounting, legal, or other competent advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation. Home value estimate calculators provided herein are general estimations based on publicly available data and should not be used as a substitute for a professional appraisal. The information is provided “as is,” with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability, and fitness for a particular purpose.
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