Most people refinance to save money. That usually means jumping to a lower rate. But you also can save big bucks by trimming the term of your loan, possibly at the very same low rate.
Most lenders today offer the same 30-year rate on mortgages with terms of 20 to 29 years, according to Karen Mayfield of Bank of the West. And most offer the same 15-year rate on loans with durations of eight to 15 years.
You may not save any money immediately, at least not in terms of your monthly payment. But you could save a bundle in interest over the shorter life of your new mortgage. Plus, you'll build a nest egg that much faster.
The potential drawback to shorter-term mortgages is that your tax deduction for mortgage interest won't be as large. But that's a questionable disadvantage.
For one thing, interest is cash out of your pocket. Why spend the money if you don't need to?
For another, mortgage interest is not a dollar-for-dollar write-off. Rather, the deduction is based on your income-tax bracket. So if you are in the 15 percent bracket, you'll get back only 15 cents for every dollar in mortgage interest you spend.
Then there's the question of whether mortgage interest will remain deductible. Granted, it's a long shot right now that Congress would eliminate the benefit. But make no mistake, the once-sacrosanct write-off will be on the table if and when lawmakers ever reform the nation's tax code.
So, with the deduction argument out of the way, let's look at some possibilities using, for simplicity's sake, a loan amount of $300,000.
Say you have a 4-year-old, 30-year mortgage at 6.5 percent, with a monthly payment to principal and interest of $1,896. If you refinance at 4 percent into a new 30-year mortgage of $288,000 (your present balance of $285,179, plus $2,821 in closing costs wrapped into the loan amount), your payment will drop to $1,375, a significant monthly savings of $521.
But you'd be starting all over again. As a result, on top of the $76,196 in interest you've already spent on the original mortgage, you'd be paying an additional $206,984 in interest over the term of the new loan.
Sure, most people don't keep the same house, let alone the same mortgage, for 30 years. Indeed, the average life of a home loan is about seven years. But if you do, if this is your final castle, you will be paying for it for 34 years, not 30.
Now, suppose that instead of opting for a lower payment, you decide to shoot for the same monthly payment but reduce the term of the loan. A new $288,000 mortgage at 4 percent over 20 years will run $1,745 a month.
That cuts your monthly outlay by about $150 and saves a whale of a lot of interest -- $130,854 for the 20-year loan at 4 percent vs. $206,984 for the 30-year loan at 4 percent and $382,633 for your original loan.
Better yet, you are not starting over. Again, most people don't keep their loans forever. But as Mayfield rightly points out, people's lifestyles do change. And as they do, it's sometimes necessary to have a nest egg.
Say, for example, that 10 years from now, Junior wants to go off to college, or Priscilla wants to get married. Either way, you're going to need some cash. Good for you if you've been saving regularly for these kinds of events. But if you haven't, you still might be able to borrow what you need at the going interest rate.
Another option is to take it out of the equity you've built up in your house. Just how much equity might be available a decade from now will depend on two factors: appreciation, or how much your place has increased in value, and the term of your mortgage. Only one, the loan's term, is a sure thing.
If you opt for the new 30-year loan in the above example, you will have accumulated $51,102 in equity by making your payment every month over 10 years. Why so little? Because in the early years of any mortgage, the lion's share of the payment goes to interest. In fact, it isn't until the 20th year or so that more of the payment is earmarked for principal than interest.
Mortgages with shorter terms amortize, or pay down, faster than those with longer terms. So if you opt for the 20-year loan above, you will have amassed $115,624 in equity after 10 years. That's more than double the equity buildup.
Shortening the length of your mortgage isn't for everyone. But if you are comfortable making roughly the same payment as you are now, it is worth considering. "Do the math," Mayfield advises.
Another sometimes overlooked refinancing option, especially if you have a good idea how long you might keep the house, is a hybrid adjustable mortgage, one with a rate that is fixed for five or seven years before it begins to adjust annually.
Most people are jumping out of ARMs to fixed-rate loans these days because of the certainty the new loans offer. "Knowing your monthly payments won't rise in the future provides a lot of peace of mind," Mayfield says.
But hybrid ARMs offer a degree of certainty, too. And adjustable loans aren't nearly as dangerous as many people think.
With today's fixed rates at near record-low levels, the rate on ARMs surely will rise when the fixed-rate period expires five to seven years from now. But caps on the annual increase will limit the pain if you misjudge your expected moving date.