Refinancing your mortgage and switching to a shorter term might help you save money, but it doesn’t work that way in all circumstances. For some homeowners, paying off a mortgage early can cost more or make it harder to achieve other financial goals.
Reasons to Consider Switching to a Shorter Term
A mortgage with a shorter term has a lower interest rate than a longer-term loan. Shortening the term of your mortgage would help you spend less on interest over the life of the loan and pay off the mortgage sooner.
Why Refinancing Might Not Be the Right Move
Shortening your loan term would increase your mortgage payments significantly. That could be a financial stretch, especially if your job isn’t secure, your income varies or you are raising a family. Refinancing would also require you to pay closing costs.
If you need to save for retirement or for your children’s college education, it might be better to focus on those goals first. When it comes to saving for retirement and education, the earlier you start investing, the more you can benefit from compounded interest.
High-interest credit cards can eat up a large chunk of your monthly income and can take a long time to pay off. You might be better off tackling your credit card bills before refinancing your home loan.
Paying off your mortgage earlier could help you build equity, but those funds would be harder to access than money in a savings account. If making higher monthly mortgage payments would leave you without a readily accessible source of cash, refinancing might not be a good idea.
At the beginning of a mortgage repayment period, a large portion of each payment goes toward interest. Later, more money is used to reduce the principal. If you’ve been paying off your mortgage for several years and most of your payments now go toward principal, refinancing would set you back to the stage where most of your payments went toward interest. Depending on your specific circumstances, you might lose money overall.
Other Ways to Pay Off Your Mortgage Faster
If your current mortgage doesn’t have a prepayment penalty, you could pay a little extra each month or make extra payments with money from a bonus, income tax refund or gift. Just be sure to instruct your loan servicer to apply the additional payments to your principal.
Should You Refinance?
Shortening the payback period and reducing the total amount of interest you will have to pay can be appealing, but those shouldn’t necessarily be your top priorities. Depending on where you are in your repayment period, refinancing might not save you much money, or any at all. Increasing your monthly payments could also make it difficult to reach your other financial objectives. Think about all your goals and your overall financial situation to decide whether refinancing to a shorter loan term is the best move.