There are many reasons to refinance your mortgage, from getting a lower rate to taking cash out, while some homeowners may be interested in refinancing for a shorter loan term. This financing strategy can allow homeowners to pay down their mortgage quicker and with a lower interest rate. However, this route may not be for everyone, so it’s important to be aware of the benefits and drawbacks associated with refinancing for a shorter-term mortgage.
Increase monthly payment amount
When you refinance for a shorter-term mortgage, you can expect your monthly payments to increase, and usually by a fairly significant amount. This should come as no surprise – if you’re refinancing from a 30-year to a 15-year mortgage, you are paying down the mortgage in half the time, which will naturally result in larger monthly payments. However, this may not always be the case, which we will explore more in the sections below.
It’s important to keep in mind what monthly payments you can afford, as refinancing for a shorter-term mortgage and then failing to make the larger monthly payments will result in hits to your credit score and could put you at risk for foreclosure.
Lower your interest rate
When you refinance for a shorter-term mortgage, you could also be eligible for lower interest rates. However, your mortgage lender will still need to take your debt-to-income ratio into consideration. If the increased monthly payments that accompany a 15-year mortgage term will push your DTI up significantly, you may not receive the lowest possible interest rates.
Grow your equity
If your home financing goal is to increase your equity in your home, then refinancing for a reduced mortgage term could be an ideal option for you. When you refinance for a shorter-term mortgage, you’ll likely end up with a lower interest rate along with higher monthly payments. This will, of course, result in growing the equity in your home at a much faster rate than with a longer-term mortgage.
Consider what remains of your current mortgage
If you just purchased your home more recently, say within the past 5 years or so, you can expect an increase in your monthly payments to occur when you refinance for a reduced loan term. However, if you’ve been paying down your mortgage for years now and only have a few years left, reducing the loan term could result in lower monthly payments. While this may seem counter-intuitive, when you cut only a few years off your loan term while getting a lower interest rate, your monthly payment could increase less than the amount you’ll be saving due to the lower interest rate, resulting in a lower monthly payment.
There’s some complicated math that goes into calculating your mortgage and interest payments, but mortgage calculators can help you see the picture more clearly and make a decision that would best fit your financing goals.
Refinancing your mortgage for a shorter-term mortgage may not be the best financial decision for everyone. However, if you think you could afford a higher monthly payment (in some cases) and are interested in growing your equity in your home, it could be the right option for you. If you’re ready to take the next step to refinance, get started now!
