For many mortgage holders, the idea of refinancing is unappealing. Each time you refinance, the clock resets. Basically, you could be turning back the mortgage clock 30 years every time you do a refi. In some cases, particularly if you are just a few years away from paying off your loan, refinancing may be a poor choice. (credit.com)
But for many homeowners, there are methods to do a refi without starting over on the loan term.
30 Year Fixed Rate Loan Example
The traditional, 30 year, fixed rate mortgage is the most popular home loan. If you are refinancing to drop the payment, reduce the rate or pull out cash, you are starting over the loan for a new 30 year term.
With rates still in the 4s in many cases, there still are chances to cut your payment be reducing the rate. When beginning a new loan term, and the payment is dropped, the key is to make the exact same payment on the new loan that was made on the current loan. Doing so ensures you will enjoy the benefit of lower loan interest costs, a faster time to pay off the loan, and of course, you also can make lower 30 year payments if your financial situation worsens.
For example, a smart customer may benefit by taking out a new 30 year note with a 1% lower rate, in exchange for $300 in savings per month. By making a payment of $1700 on a principle of $282,000 at 4.375%, rather than the payment of $1400 that is due every month, the home loan will be paid off in just 21 years rather than 26 with the higher rate. Also, this homeowner always can go back to the lower payment if there is a financial difficulty.
If the same payment that was being made on the old loan is paid on the new one with a lower payment, the home loan gets paid off years faster.
30 Year Term
A monthly payment that is higher needs to be made rather than the lower payment that is due at present to make the principal drop faster. It will require you to have regular diligence to stick to making an overpayment every month beyond what is really due.
25 Year Term
Another option for the homeowner who wants to reduce the principal over time is to get a 25 year mortgage. You could be free of a mortgage five full years sooner than the regular 30 year term, if you can handle a higher payment. Using the above example of a loan of $282,000, with a payment of $1154, an extra $141 per month to not have to worry about making a higher principal prepayment.
20 Year Term
This loan will be paid off at 240 months. This is 10 years shorter than taking a 30 year term loan and making an additional principal prepayment. So, you can expect a higher monthly payment and not have the ability to go back to a lower mortgage payment.
15 Year Term
This choice gives you the quickest payoff, with a payment that is almost double the 30 year mortgage payment. Your advantage? You get 15 years of being mortgage free. But remember that not all rates on each of the programs are identical. In many cases, the shorter the term of the loan, the lower the rate.
For instance, the 15 year mortgage is given the lowest rates. Fifteen year mortgages are more attractive to the secondary mortgage purchase market as most loans are refinanced every five to seven years. A 15 year note means the borrower will pay more interest in a shorter time. This makes the loan much more attractive to the investor.
How to Make Sure You Are Not Resetting?
If you opt for a 30 year loan and make bigger payments, make sure you are able to shoulder the additional principal payment. Also, be sure the total loan amount is lower than the original balance; this does not include cashing out your loan unless you opt for a shorter term, such as a shorter 15 year term.
Further, the interest rate should be the same or lower than the rate on the loan that is being paid off now. If there is mortgage insurance on the loan that is being paid off and the new loan has a higher rate, removing the mortgage insurance will really offset the higher rate on the refinance.
- How to Refinance Without Resetting the Mortgage Clock. (2019). Retrieved from https://blog.credit.com/2013/12/how-to-refinance-without-resetting-the-mortgage-clock-71689/