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Less Is More When It Comes to Refinancing

by Kristi  Shibata
Mortgage Directory Columnist

It has been reported that 60% of mortgage applications in 2008 were refinance transactions. Homeowners are taking advantage of the opportunity to lower their rates, secure better mortgage terms, or cash in some equity. But there's another way refinancing can improve financial futures--by making it possible for homeowners to retire their mortgage early.

The Benefits of a Shorter Mortgage Term

If you refinance your mortgage, consider accelerating your payments or changing the term of your loan. Refinancing at a lower rate gets you a lower payment. But what if you keep making your old, higher payment, and use the difference to reduce the principal balance on your loan? You could build equity faster, pay off your loan sooner, and save potentially thousands in interest charges over the life of your loan.

For example, if you took a $300,000 mortgage 5 years ago at 7.5%, your payment would be $2,098 a month, and you would owe $284,494 after 5 years. Suppose that now you refinance that remaining balance at 6%. Your payment would be $1,706, but it would take a total of 35 years to pay off your mortgage. By continuing to make your old payment, you would knock an extra $394 of your balance each month. You'd pay off your mortgage 11 years sooner and save an extra $137,676 in interest!

Using a Mortgage Calculator to Refinance

The advantage of making extra payments to reduce your balance is that you aren't obligating yourself to make a higher payment--like you would if you chose a 15 year loan. However, homeowners who can commit to the shorter term are often rewarded with substantially lower interest rates.

Mortgage calculators can help you determine if you can afford the payment on a 20, 15, or 10 year loan. You can see how the shorter term will increase your payment, and how the lower rate can offset that somewhat. It will also show how much interest you will save over the life of the loan, and how much faster you can accrue equity.

You can enter your current rate, loan amount, and how many years you have had your current mortgage to determine your break-even point and see if refinancing will pay off. Those who need to lower their payment to a more manageable amount will not be looking to accelerate their mortgage payoff. In that case, stretching out the remaining balance over a longer period can be a tool for getting finances under control. Loan term is one of many variables that homeowners can change to fit their current needs and long term goals.

By using a mortgage calculator and checking with several lenders, you can evaluate mortgage options and find the best rate and term to meet your objectives.

Sources: About the Author
Kristi Shibata is a public relations and communication specialist and regular Mortgage Directory columnist. She graduated from University of California, San Diego, with a BA in Communications.

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