Who Should Refinance into a Shorter Term Mortgage?
The near historic low interest rates have many homeowners clamoring to not only refinance their mortgages, but also secure a shorter term loan.
But whether or not it makes sense to reduce your loan time depends on your income, current interest rate and how long you plan to stay in the home.
“It’s certainly dependent on the consumer’s ability to afford a higher monthly payment,” says Rick Allen, chief operating officer for Mortgage Marvel. “In most cases consumers will see an increase.”
Refinancing into a 15-year-fixed-rate loan from a 30 year is an attractive option for many because it means paying down the mortgage faster and saving money on interest over the life of the loan.
For people who have a high-interest rate and refinance into a drastically lower rate, it could shorten the term and they won’t see any increase in the monthly payment. But for most people, the shorter loan will cause a bump in their payment.
“If you don’t have extra money left over at the end of each month and can’t afford the higher payment it’s not right for you” says Tony Garcia III, retail regional sales manager at Wells Fargo.
Mortgage experts say people who a steady and reliable cash flow and have extra disposable income are prime candidates to refinance into a shorter term mortgage. While the underwriting process is the same for a refinance into a 15-year or a 30-year mortgage, in most cases you’ll need a higher debt to income ratio with a 15-year loan simply because the monthly payment will be higher.
In addition to paying it off quicker, Garcia says a 15-year mortgage typically carries a lower interest rate than a 30-year loan.
Affordability of the new loan is one consideration to take into account, but borrowers also have to take into account the costs associated with a refi and the fact that the loan resets to the new term. If you are 17 years into a 30-year-fixed loan it may not be worth taking on the closing costs to refinance into a new 150-year loan.
How long you plan to stay in the house should also be considered. If you are only going to stay in the house for two years, the costs to refinance may outweigh the savings. “If you don’t plan to be in the house for long in most cases it’s not worthwhile to refinance because of the expenses,” says Allen.
According to mortgage experts, if you are a good candidate to refinance into a shorter term loan and have an interest rate at 4% or higher than its something to seriously consider if you haven’t refinanced in the past six months. “It makes sense when people are looking to pay off the loan in a quicker time frame. It makes sense if they want to save on the interest over the life of the loan and it makes sense if they are looking to build equity,” says Garcia. “A lot of times it does make sense.”
While loans in increments of 15 years are the most common, some mortgage lenders will let you refinance into a 20-year or even 18-year loan, so be sure to shop around. Garcia says that if you are thinking about doing it, it’s better to act sooner rather than later.
“Rates are at attractive levels right now,” says Garcia. “They are not going to stay at historic levels so don’t wait until it’s too late to take advantage of the low rates.”