Mortgage Refinancing: The Long and the Short of It

By Richard Barrington
Calculators for Mortgages Columnist

Email this Article | Format for printing

    Lower mortgage rates have given many home owners an opportunity to save money by refinancing. While it might seem natural to trade in your existing 30-year mortgage for a new 30-year mortgage with a lower interest rate, other options might make more sense. A refinance calculator can help you explore those options, and possibly increase your interest savings.

Matching Time Periods

    At the heart of the matter is the fact that a 30-year mortgage  is no longer a 30-year mortgage once you start paying it down. For example,  if you've been paying off your 30-year mortgage for 10 years, you essentially  have a 20-year mortgage at this point. This means a 15-year mortgage may be  a better match with the time remaining on your current mortgage. The kicker  is that refinancing to a 15-year mortgage rather than a 30-year would add to  your interest savings. 

Matching Payments

Naturally, the drawback of a shorter loan is that it results  in larger monthly payments. However, if you have already paid down your 30-year  mortgage for several years, spreading the remaining balance over 15 years may  not result in that great a jump in your monthly payments -- especially when  the interest rate savings is factored in. 

Let's look at an example. Suppose you have a $150,000 balance  remaining on a 30-year mortgage you've been paying for 10 years. A 30-year  mortgage rate from 10 years ago would be about 7.13%, giving you a monthly  payment of $1,174.68. By the end of March, 2008, 30-year mortgage rates were  down to 5.85%, so you could refinance to a 30-year mortgage and lower your  monthly payment to $884.91 -- a no-brainer, right?  

Consider another option. Since you only have 20 years left  on your existing mortgage, you could refinance to a 15-year mortgage. Because  you would now be paying your remaining balance over a shorter period of time,  your monthly payment would increase. However, since 15-year mortgage rates  were down to 5.34% at the end of March, that increase would not be very large.  Your payment would go from $1,174.68 to $1,212.93. 

Why would anyone refinance to increase the payment? Because  shortening the mortgage term reduces interest expense in the long run. In this  case, refinancing to a 15-year mortgage would reduce your total remaining interest  payments to $68,326.81, compared to $131,923.70 with your existing mortgage,  or $168,568.10 if you refinance for 30 years. That's right -- refinancing to  a 15-year mortgage could be $100,000 cheaper than refinancing to a 30-year  mortgage!   

   

Understanding Your Reasons for Refinancing

    Ultimately, the right decision depends on your reasons for  refinancing. If you are refinancing to lower your monthly payments for budget  reasons, then by all means a longer time period make sense. On the other hand,  if you are trying to save money on interest over the life of the loan, a shorter  time period is worth considering. A refinance  calculator will help you find the approach which best fits your intentions.  

Source: 
Freddie  Mac



About the Author
Richard Barrington is a freelance writer and novelist who previously spent over twenty years as an investment industry executive.