Should You Refinance to a Shorter-Term Mortgage?
Homeowners who refinance to a shorter-term mortgage can save on interest costs and reach the goal of owning their home outright sooner. But if you plan to refinance into a shorter loan term, be prepared for a larger monthly payment and its effect on your household budget.
On the flip side, if you refinance into a longer loan term or avoid refinancing altogether, you’ll have smaller monthly payments but you’ll pay more in interest over your loan’s lifetime.
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What is a refinance and how often can you do it?
Refinancing a mortgage means taking out a new loan that will replace the old loan by paying it in full. The purpose of refinancing a home is to get into a loan that better suits your needs, so borrowers need to understand which refinance loan terms correlate with the results they want.
- If you shorten your loan term, you’re looking at larger monthly payments, but in return you’ll save with lower lifetime interest costs.
- If you lengthen your loan term, you’ll lower your monthly payments but pay more in interest over the life of the loan.
- If you reduce your interest rate, you’ll pay less in total interest on the loan and may also reduce your monthly payment.
- If you convert from an adjustable-rate to a fixed-rate mortgage, you’ll likely save on interest costs, since most adjustable-rate mortgages (ARMs) will charge higher interest rates than fixed mortgages offer, once they begin adjusting. You’ll also avoid the instability of varying monthly mortgage payments.
- If you refinance to tap your home’s equity, you can access cash or consolidate debts, but you’re also likely to pay far more in interest and push out the date by which you’ll own your home outright.
There’s no rule about how often you’re allowed to refinance, but keep in mind that you’ll have to pay closing costs each time you refi.
Some lenders may charge a prepayment penalty to borrowers who pay off their loan before the agreed-upon term ends, so read the fine print in your purchase contract.When does it make sense to refinance to a shorter-term mortgage?
If your goal is to pay the least amount of loan interest possible, or to pay off your mortgage much sooner, you may find refinancing to a shorter-term mortgage beneficial. Your monthly mortgage payment will be higher, but you’ll save money over time. You’ll likely also benefit from a lower interest rate by choosing a short-term mortgage.
Let’s consider an example of a borrower’s refinance to a 15-year mortgage. Their existing loan has a 30-year repayment term and 6.42% interest rate, and they’ve been paying it down for 5 years.
| Existing 30-year loan | Refinanced 15-year loan | |
|---|---|---|
| Loan amount | $296,000 | $273,913 |
| Interest rate | 6.42% | 5.68% |
| Monthly payment | $1,855.38 | $2,407.01 |
| Total interest costs of each loan individually | $371,935.15 | $133,669.46 |
| Total interest costs for the home | $371,935.15 | $214,852.55 |
As you can see, refinancing to a 15-year loan makes your monthly payment jump up by about $550, but the tradeoff is that the total interest costs paid on your home will be more than $157,000 lower than if you had stayed with the 30-year mortgage.
Pros and cons of refinancing to a shorter-term loan
| Pros | Cons |
|---|---|
You’ll build home equity faster You’ll pay less interest over the life of your loan You’ll have a lower interest rate compared to a longer-term loan | You’re locked into a higher mortgage payment You’ll have less wiggle room in your monthly budget You may have a harder time qualifying, depending on your income |
When does it make sense to refinance into a longer-term mortgage?
A longer-term mortgage may make more sense if shrinking your monthly payment is your primary goal. You’re trading the higher monthly payment of a short-term mortgage for a more expensive loan, though.
Revisiting the earlier example, staying with the 30-year mortgage would cost you far more in interest than if you refinanced into a 15-year loan — $371,935.15 versus $214,852.55.
Pros and cons of refinancing to a longer-term loan
| Pros | Cons |
|---|---|
You’ll have a lower monthly payment You may get a lower interest rate compared to your current rate You might have room in your budget for extra principal payments | You’ll have a higher interest rate You’ll pay more in interest over the life of your loan You’ll build home equity at a slower pace |
Should I refinance or pay extra?
Deciding whether to refinance to a shorter-term mortgage ultimately depends on what’s most comfortable for your situation. Before you move forward, factor in the following considerations:
→ Do you plan to move anytime soon?
Before you shell out 2% to 6% of your new loan amount in the form of refinance closing costs and fees, first calculate your break-even point, or the number of months it’ll take you to recoup your refi costs.
LendingTree’s refinance calculator can help you estimate your break-even point, as well as your lifetime interest savings.
→ Can your budget handle a higher mortgage payment?
Shorter loan terms may come with a lower interest rate, but that won’t do you any good if you can’t afford the mortgage payment. An unexpected illness, job loss or other financial setback could make your payments unaffordable and put you at risk of mortgage default.
You can’t predict the future, of course, but it’s wise to have a backup plan for these scenarios, such as a larger emergency fund.
→ Are you prepared for the tax implications of a short-term mortgage?
Homeownership comes with many benefits, including tax incentives. These include the mortgage interest deduction, which allows you to deduct your loan interest payments from your taxable income each year.
Since you’ll pay significantly less interest with a shorter loan term, you won’t be able to deduct as much interest as a borrower with a longer repayment term. Consult your tax professional for more guidance.
Alternatives to refinancing to a short-term mortgage
1. Make biweekly payments
Divide your payment amount by two and make biweekly mortgage payments. Over the course of a year, you’ll have made 26 half payments, or 13 full payments. Sticking to this schedule can shorten your loan term by a few years.
2. Request a mortgage recast
If you have a lump sum set aside that you’d like to put toward your mortgage balance, ask your lender about recasting your mortgage. You’d shrink your outstanding balance and end up paying less each month, since your lender recalculates your mortgage payments based on a smaller principal amount.
3. Earn extra income to pay down your loan balance
If you pick up a part-time gig or side hustle, your earnings can help you chip away at your loan’s principal balance more quickly.