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Should You Refinance to a Shorter Term Mortgage?

Refinancing a 30-year mortgage to a 10-, 15- or 20-year loan allows you to pay off your home faster but requires a higher monthly payment. Or you can look at ways to speed things up without refinancing.
March 19, 2020
Managing Your Mortgage, Mortgages
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NOTE: Due to the coronavirus outbreak, refinancing may be a bit of a challenge. Lenders are dealing with high loan demand and staffing issues. If you can’t pay your current home loan, refer to our mortgage assistance resource. For the latest information on how to cope with financial stress during this emergency, see NerdWallet’s financial guide to COVID-19.

You might think that refinancing your mortgage to a shorter-term loan is a win-win: You save on interest and pay off your home sooner. But there may be other ways to achieve those goals.

To figure out whether paying your home off sooner makes sense for you, ask yourself these questions:

Can I afford a higher mortgage payment?

For some homeowners, especially those who have young families or who are cash-strapped for other reasons, squeezing an extra few hundred dollars out of the monthly budget and limiting access to ready cash may be a risk. Shorter-term loans offer lower interest rates but can come with substantially higher monthly payments. Since failing to make payments will harm your credit and could put you in jeopardy of losing your home, you need to be sure that larger payments fit your budget.

» MORE: Compare monthly and lifetime costs for 15-year vs. 30-year mortgages

Even if you feel confident about your ability to make bigger monthly payments, your debt-to-income ratio must be low enough to prove to a lender that you can afford it. For most loans, your DTI, including home-related expenses, should be no more than 36%, according to Fannie Mae, a government-sponsored enterprise that guarantees mortgages.

A higher DTI doesn’t necessarily mean you’ll be turned down for a loan, but it makes you unlikely to get a lender’s lowest rate. Keep in mind that lenders include all your debt when calculating DTI. If you have substantial credit card debt or a sizable car payment, prepare yourself for a higher mortgage rate.

» MORE: Find current refinance rates

Will I be able to meet my other financial goals?

A mortgage refinance to a shorter-term loan may work if you have few long-term debts and enough money coming in each month to pay your bills (with extra cash to spare). But if your budget is tight or you’re not contributing to other savings, putting more money into your home may not be an optimal long-term strategy.

Rather than build home equity faster, it might make better financial sense to put that money to work in other ways, such as a 529 college fund, retirement accounts, life insurance policies or investments.

» MORE: Investing vs. paying off your mortgage

How much of my mortgage have I already paid off?

Depending on how far along you are on repaying your mortgage, moving to a shorter-term loan can be an expensive mistake.

If you refinance an 18-year-old mortgage to a 10-year loan, you’ll go back to paying more in interest upfront, and you might actually lose money.

Amortization means that mortgage payments are front-loaded with interest. For example, if you’re in the third year of your mortgage, you’re paying more toward interest than to your principal. But if you’re on year 18 of your mortgage, you’re likely paying more toward your principal than interest. If you refinance an 18-year-old mortgage to a 10-year loan, you’ll go back to paying more in interest upfront, and you might actually lose money once closing costs and refi fees are taken into account.

» MORE: Mortgage refinance closings costs to watch out for

Am I planning to move within the next few years?

If you plan to stay in your current home for only a few more years, refinancing might not save you money. Figuring out your savings isn’t just about the interest rate — you also need to consider the costs that go into refinancing your mortgage. Dividing the total loan costs by your monthly payment savings will give you the number of months it will take to reach the break-even point. If you don’t stay in the home long enough to reach the break-even, you won’t see any savings before you move.

Can I pay off my loan faster another way?

Refinancing isn’t the only way to shorten your mortgage. With these strategies, you won’t change your interest rate, but you also don’t have to pay closing costs. Here are some ways to pay off your mortgage more quickly without refinancing to a shorter-term loan.

  • Take your current mortgage payment, divide it by 12 and add that amount to your monthly payment. (Check with your lender, and keep an eye on your monthly statements, to be sure the extra amount goes toward principal, not interest.) If you make those additional payments consistently, you could knock years off of a 30-year mortgage.
  • Another way to add an extra monthly payment is to go on a biweekly mortgage payment schedule. Paying every two weeks gives you the equivalent of a thirteenth payment. Though some lenders make biweekly payment schedules fairly painless, be wary of setup fees or of using a third-party servicer, which can diminish your savings.
  • Crunch the numbers on what the payments would be on a shorter-term loan, and simply make those exact payments each month without going through the motions of refinancing. If you’re short on cash some months, you can simply revert to your standard payment amount without the risk of penalties.

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