Save by switching to a short-term loan
Plenty of homeowners have lost equity in their homes in recent years and feel their mortgage payments are meaningless since they are paying off an asset that has dropped in value. But equity in a home is built both by increasing market value and by paying off the principal balance on your home loan. Switching to a shorter loan term when you refinance can build equity more quickly than simply opting for another 30-year fixed-rate home loan.
Recently, the Federal Housing Finance Agency (FHFA), which regulates Fannie Mae and Freddie Mac, demonstrated the benefit of refinancing into a shorter home loan, particularly for those homeowners who are underwater and owe more to their lender than the value of their property.
In the FHFA example, a homeowner with a $200,000 mortgage at 6.5 percent pays $1264 per month. Refinancing into a 30-year mortgage with a rate of 4.5 percent would reduce the payment to $1013 per month. However, if the home value is currently $160,000, it would take ten years with a new 30-year loan for the loan balance to be paid down to $160,000. The homeowner would be underwater for ten more years unless the market value of the property rises.
If the borrower opted for a 20-year loan at 4.25 percent, the monthly payment would be $1238 and the balance would go down to $160,000 in 5.5 years. Choosing a 15-year home loan at 3.75 percent would cause the monthly payment to go up to $1454, but the balance owed would drop to less than $160,000 in approximately 3.5 years.
If you are considering refinancing, be sure to compare all your options for shorter loan terms. Since 15 and 20-year home loans typically have a lower interest rate than 30-year home loans, you may find that your payments stay the same or rise only a little with a new shorter term loan. If you are comfortably making your mortgage payments now, you could benefit in your long-term financial health by switching to a shorter loan.
