Here are benefits and drawbacks to refinancing your mortgage to a shorter term.
Own your home outright faster. You’ll be free of mortgage payments sooner, too. You still must pay taxes and insurance, though. Save on interest. The savings are potentially massive. Kim McMillion, a certified financial planner and co-owner of McMillion Financial Group Springfield, MO., says she and her husband will save a whopping $128,190 in interest if they keep the new mortgage with its 3.375% interest rate for the entire 15 years. Equity builds faster. “It was noticeable right off the bat” says McMillion, who sees equity piling up quicker on her monthly mortgage statements. Even if the McMillion’s sell their home before the new mortgage is paid, they’ll pocket more cash from the sale than they would have with the old mortgage. For example, if the McMillion’s had borrowed $200,000 over 30 years at 5.25% and sold their home in the 10th year of the loan, they would have accumulated $38,424 in equity from their payments. But by borrowing the same amount over 15 years at their new rate of 3.375%, they’ll have roughly $129,000 in equity after 10 years.
1. You may not qualify. You’ll need a strong mortgage application to satisfy lenders, and your home’s appraisal must be high enough to support your loan request. That could be a problem if you have low or negative equity.
2. Your payment may grow. Depending on the fees, the size and term of your loan, and the difference between your old and new interest rates, your new monthly payment is likely to be higher, maybe much higher. Or it could remain the same. The Joys’ payment grew from $900 a month to $1,250.
3. It’s expensive. Fees of $5,000 or more could wipe out any benefit to refinancing. These charges may include an appraisal fee, inspection fee, private mortgage insurance, prepaid interest, application fee, loan origination fee, homeowners insurance, and points and fees imposed by the Federal Housing Administration or other government lending programs. The Federal Reserve’s Consumer Guide to Mortgage Settlement Costs explains mortgage fees and estimates costs.
4. The paperwork is a headache. Lenders may demand a lot of documents, from tax statements to old divorce papers. It can seem invasive. It takes months. Lenders are so busy now, and their lending requirements are so strict, that it can take months to get a loan approved. Liberty Bank, for example, averages 51 days to process a refinance from the time the application is submitted. That’s relatively quick. Some banks can take as long as 120 days. When choosing a lender, ask several about their turnaround times.
Making the call:
Nearly 80% of all mortgages in the U.S. are refinances, according to Freddie Mac, the government-managed mortgage company. Most have fixed rates. In addition to 30-year loans — the most popular option for banks such as TD Bank — there are loans with terms of 10, 15, 20 or 25 years. Adjustable-rate mortgages can have terms of three, five, seven, 10 or 15 years. (Bing: Do you need to repair your credit?) One of these shorter-term mortgages could be a good idea, but it’s a personal decision based on a lot of factors. “It depends on the individual, their equity position, their savings, where they are on the retirement spectrum,” says Josh Duda from Franklin American Mortgage. As attractive as freedom from mortgage payments may sound, it’s a mistake to stretch your finances too far, Joy says. The evidence is all around, in the stories of thousands who lost their home to foreclosure because they took on payments too big for their income. Here’s a checklist that McMillion uses for herself and clients. It can help you decide if refinancing into a higher payment is safe for you:
1. Are you funding retirement savings, including contributing at least enough to trigger the maximum amount of any matching contributions from your employer?
2. Have you saved three to six months’ worth of living expenses in a separate account for emergencies?
3. Would you have enough cash left over each month to keep paying down any other debts?
4. If you are a parent, could you contribute to your children’s college savings? If you answer yes to every question, a shorter-term mortgage may be a great idea now, especially because ultra low interest rates may not be around forever, she says.
There is a safer, middle way to go if you really want to pay down your existing loan fast but are worried about locking in higher payments: Pay something extra each month. Or make one or two extra payments each year. You can use a mortgage-payoff calculator to run your own numbers. If you want to pay off your mortgage in 20 years, you may just need to make one extra payment a year, Duda says. Whichever you decide, make sure you’re decision is perfect for you and if you need comparable before the refinance appraisal call one of our Murney Associates, Realtors for comparable, it’s free.
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