Mortgage Refinancing Without Resetting the Clock
By Scott Sheldon
For many homeowners, the thought of refinancing can be less appealing because the clock resets each time you re-mortgage. Essentially, you could be turning back the clock to 30 years each time you refinance. In some circumstances, especially if you're a few years away from paying off the debt in full, a refinance might not make sense. You're in luck though. For the overwhelming majority of homeowners, there are ways to refinance without starting over a new loan term.
A Real-Life Example: Let's start with the most popular mortgage term, a traditional 30-year fixed-rate mortgage. Whether the purposes are strictly payment reduction, interest rate reduction or cash-out purposes, the loan-term will start over a new 360 months, no two ways about it.
With rates near a low 4 percent, opportunities to reduce payment by virtue of rate reduction are still plentiful. When starting over a new term, and the payment is reduced, the key is to make the same payment on the new mortgage made on the current loan sought to be paid off. Doing so will ensure you benefit from lower interest expenses, a faster payoff time and, of course, ability to make lower 30-year payments should your financial situation ever change. This scenario is best described in a real-life example:
The original loan amount taken out in January 2009 is for $300,000 on a 30-year fixed-rate mortgage, with a 5.5 percent current balance of $282,000 and a mortgage payment of $1,703.37. The new loan on a 30-year mortgage at 4.375 percent on same principal balance of $282,000 means a new mortgage payment of $1,407.98. That's a savings potential of $296 per month on a new 30-year mortgage.
A prudent consumer with stand to benefit by taking out the new 30-year mortgage over one full percentage point lower in interest in exchange for the savings just shy of $300 per month. By making the $1,703 monthly payment, rather than the payment of $1,407.98 that would actually be due each month, the loan would be paid off in 21.3 years instead of the current 26 years remaining with the higher interest rate. Moreover, this homeowner could always revert back to the lower monthly payment in case of financial hardship. As long as the same payment that was being made on the previous loan is made on the new loan that contains a lower monthly payment, the loan can be paid off much sooner.
Your Refinancing Options:
30-Year Term: A higher monthly payment would have to be made instead of the lower payment that's presently due to have the effect of a faster principal balance reduction. It's going to require consistent diligence to to adhere to making an overpayment each month beyond the payment that's actually due. It's easy to fall off the wagon, so perhaps a shorter-term fixed-rate payment would be more suitable.
25-Year Term: This is the next best option for homeowners looking to chip away at that principal over time. You can be mortgage-free five years sooner than the traditional 30-year term in exchange for a higher payment. Using our previous example of the loan amount of $282,000, payment is $1,154, an extra $141 per month to not have to worry about making an extra principal prepayment using our scenario.
20-Year Term: This loan is paid off at 240 months, which is 10 years shorter than taking the 30-year term and making the extra principal prepayment. Again, expect a higher monthly payment without the ability to revert back to a lower payment.
15-Year Term: This option provides the fastest payoff, in exchange for a payment that is nearly double the new 30-year mortgage for an additional 15 years of being mortgage-free.
It is important to be mindful of the fact that not all of the rates on each of these programs are the same. Oftentimes, the shorter the loan's term, the lower the interest rate. For example, the 15-year mortgage is priced at the lowest rates. Why is this? Fifteen-year mortgages are much more attractive to the secondary mortgage market because most mortgages are refinanced every five to seven years. A 15-year mortgage means the borrower is paying more interest in a shorter period of time, thus making the loan more attractive to an investor. Expect 15-year loans to run one full percentage point lower in rate than its 30-year counterparts.
4 Tips to Make Sure You're Not Resetting:
• If you decide to take the 30-year option and make higher payments, make sure you can handle making extra principal prepayment.
• Make sure the total new loan amount is lower than your original balance (this would include not cashing out your mortgage unless you switch to a shorter term such as a 20-year term or a 15-year term).
• The interest rate should be the same or lower than the rate on the loan currently being paid off.
If mortgage insurance exists on the loan being paid off and the new loan contains a higher interest rate, the removal of the mortgage insurance greatly offsets even a slightly higher interest rate on the new refinance. PMI removal greatly aids in ability to make a monthly principal prepayment.
More on refinancing and related topics from Credit.com:
Want to Refinance? Here Are Some Guidelines
How to Search for Your Next Home
How to Determine Your Monthly Housing Budget
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