Original Post Date: August 26, 2012
By: Lew Sichelman
Most people refinance to save money. That usually means jumping to a lower rate. But you also can save big bucks by trimming the term of your loan, possibly at the very same low rate.
Most lenders today offer the same 30-year rate on mortgages with terms of 20 to 29 years, said Karen Mayfield of Bank of the West. And most offer the same 15-year rate on loans with durations of eight to 15 years.
You may not save any money immediately, at least not in terms of your monthly payment. But you could save a bundle in interest over the shorter life of your new mortgage. Plus, you’ll build a nest egg that much faster.
The potential drawback to shorter-term mortgages is that your tax deduction for mortgage interest won’t be as large. But that’s a questionable disadvantage.
For one thing, interest is cash out of your pocket. Why spend the money if you don’t need to?
For another, mortgage interest is not a dollar-for-dollar write-off. Rather, the deduction is based on your income-tax bracket. So if you are in the 15% bracket, you’ll get back only 15 cents for every dollar in mortgage interest you spend.
Then there’s the question of whether mortgage interest will remain deductible. Granted, it’s a long shot right now that Congress would eliminate the benefit. But make no mistake, the once-sacrosanct write-off will be on the table if and when lawmakers ever reform the nation’s tax code.
So, with the deduction argument out of the way, let’s look at some possibilities using, for simplicity’s sake, a loan amount of $300,000.
Say you have a 4-year-old, 30-year mortgage at 6.5%, with a monthly payment to principal and interest of $1,896. If you refinance at 4% into a new 30-year mortgage of $288,000 (your present balance of $285,179, plus $2,821 in closing costs wrapped into the loan amount), your payment will drop to $1,375, a significant monthly savings of $521.
But you’d be starting all over again. As a result, on top of the $76,196 in interest you’ve already spent on the original mortgage, you’d be paying an additional $206,984 in interest over the term of the new loan.
Sure, most people don’t keep the same house, let alone the same mortgage, for 30 years. Indeed, the average life of a home loan is about seven years. But if you do, if this is your final castle, you will be paying for it for 34 years, not 30.
Now, suppose that instead of opting for a lower payment, you decide to shoot for the same monthly payment but reduce the term of the loan. A new $288,000 mortgage at 4% over 20 years will run $1,745 a month.
That cuts your monthly outlay by about $150 and saves a whale of a lot of interest — $130,854 for the 20-year loan at 4% versus $206,984 for the 30-year loan at 4% and $382,633 for your original loan.
Better yet, you are not starting over.
Shortening the length of your mortgage isn’t for everyone. But if you are comfortable making roughly the same payment as you are now, it is worth considering. “Do the math,” Mayfield advises.