What if one could use a lower rate to shorten the term of their mortgage? Ordinarily, refinancing will increase the term of a mortgage. For example, if a homeowner obtained a 30 year loan three years ago and refinanced today, they would be increasing the term from 27 years to 30 years. However, if they are lowering the rate, they could also opt to decrease the term at the same time. Let’s take a hypothetical example. Note that all rates and payments in this example are for example purposes only and are approximate. In addition, the issue of closing costs for each option are not addressed.
$300,000 Present Mortgage
5.0% Rate
Principal and Interest Payments of $1,610
Let’s say rates have dropped and the homeowner has the three hypothetical options. The following chart demonstrates these in terms of payment reduction or increase as well as term reduction or increase—
Present Loan |
Rate |
Term |
Principle & Interest Payment |
Change |
Term Change |
| Present Loan | 5.0% | 30 year | $1,610 | N/A | N/A |
| Option One | 3.75% | 30 year | $1,390 | -$220 monthly | +36 months |
| Option Two | 3.625% | 20 year | $1,760 | +150 monthly | -84 months |
| Option Three | 2.875% | 15 year | $2,050 | +440 monthly | -144 months |
Which is the best alternative in this situation? It depends upon the financial situation of the homeowner and that is why a financial advisor is an important ingredient within the process. The answer for someone who is 30 years old and someone who is 50 years old could be completely different. Variations in income levels, cash reserves, retirement objectives and more would all be a consideration.
In the next segment we will look at an additional objective which might be achieved through refinancing – paying off consumer debt.
