Posted May 28, 2014Tweet
Mortgage rates are at a 12-month low. It's a terrific time to refinance. But what if you don't want to reset your loan to 30 years?
The good news is that you don't have to. With a little bit of savvy, you can take advantage of today's mortgage rates and shorten the number of years remaining on your loan. It all comes down to a financial term known as amortization (ah-mor-ti-ZAY-shun).
Amortization (ah-mor-ti-ZAY-shun) is the schedule by which your loan balance goes to $0 over time; and it can be manipulated for your benefit. You're the homeowner, and you're in control.
When a bank sets your monthly principal + interest mortgage payment, it's based on the principles of amortization. With a mortgage, amortization tends to favor the bank -- the early years of a home loan are very heavy on interest payments and very low on principal.
If you've ever looked at your mortgage statement after a few years and thought, "I haven't paid this thing down a bit!", it's because of amortization. This is true for all fixed loan types, too, including the 15-year fixed-rate mortgage; a 20-year fixed-rate mortgage; and, the 30-year fixed-rate mortgage.
For example, look at these numbers on a fixed-rate amortization schedule.
If you were to borrow $300,000 from the bank at a mortgage rate of 4%, after 10 years, here is how much you would still owe given various mortgage products :
With the 15-year home loan, you would have made a significant dent in the original loan balance. With the 30-year mortgage, by contrast, you've barely paid down anything at all.
At 4 percent, it takes 19 years, 4 months to pay a 30-year mortgage to pay down by half. This is decidedly bank-friendly.
It's also one reason why 15-year mortgages are so popular -- homeowners with 15-year loan pay much less mortgage interest over time as compared to homeowners with 30-year loans or 20-year loans.
The good news is that you're not "stuck" with a 30-year mortgage and its high costs of interest -- especially with current mortgage rates are as low as they are today.
Your first option to save on mortgage interest is to refinance into a new, shorter loan term.
If your initial mortgage was a 30-year fixed rate mortgage, for example, you can choose to lower your term to, say, 20 years or 15 years. Reducing the number of years in your mortgage "accelerates" your amortization and the loan pays off quicker.
When you switch to a shorter loan term, you also get avoid "starting your mortgage over" for another 30 years. You get a new loan, with a shorter term. You'll save big on your long-term interest costs.
At today's mortgage rates, homeowners using a 15-year mortgage will pay 65% less interest than homeowners using a thirty.
However, payments on a 15-year mortgage can be substantially higher as compared to longer-lengthed loans. This is because you're compressing the repayment period into a lesser number of years.
With a 15-year mortgage, your monthly mortgage obligation may jump as much as forty percent. For many U.S. households, that kind of increase can be too much to stomach. This is why some homeowners skip the refinance and opt to "prepay" their mortgage instead.
To prepay your mortgage means to send "extra" payments to your lender each month, chipping away at the amount you owe faster than your amortization schedule prescribes.
For example, if your mortgage payment is $1,750 per month, and you send $2,000 to your lender, you've reduced your amount owed by $250.
Prepaying a mortgage shorten your loan term because the loan's balance will get to zero more quickly. The more you prepay, the more money you'll save.
Also, you can prepay nearly all mortgages with penalty. Government-backed mortgages -- which includes all FHA loans, VA loans, USDA loans and conventional loans -- come with no prepayment penalty ever.
There's a third way to reduce your mortgage interest paid. It's called "refinance-to-prepay".
Refinance-to-prepay is exactly what it sounds like -- you refinance to a lower rate and prepay on your loan. It's a plan that can give the best of both options -- access to today's low mortgage rates, plus a quicker amortization schedule.
Here's how to refinance-to-prepay, and save in interest costs :
The refinance-to-prepay system works because, although your mortgage rate is lower, you're making the same payment to the bank each month. There's less interest being paid at the same time that you're "accelerating" your loan payback.
With refinance-to-prepay, you can "restart" your loan to 30 years but then pay it off faster than if you had never refinanced at all. It's a trick of math that plays on bank amortization schedules.
Here's a real life example of how refinance-to-prepay can work.
Say your current loan balance is $400,000 and you're refinancing from the 4.75% mortgage rate you took two years ago to a zero-closing cost 4.00% mortgage rate available today. With the refinance, your payment drops $246 per month so you take that $246 and send it to your lender along with your "regular" payment.
By prepaying your mortgage principal in this way, your "new" 30-year loan will pay off in full in just 24 years -- four years faster than if you hadn't refinanced at all. Those four years of "no payments" save $90,000.
Now, this example assumed a zero-closing cost mortgage at 4.00 percent. Even with closing costs, the maths works out. You're spending a little, and saving a lot.
With mortgage rates at 12-month lows, it's a good time to refinance. There are hundreds of billions of outstanding U.S. mortgages with rates over 5%. Opportunities are big today -- and you can refinance without "losing years" on your mortgage.
Compare today's low rates to your existing mortgage. See how many years -- and how much interest -- you can save off your mortgage. Rates are available online at no cost, with no obligation to proceed, and with no social security number required to get started.
The information contained on The Mortgage Reports website is for informational purposes only and is not an advertisement for products offered by Full Beaker. The views and opinions expressed herein are those of the author and do not reflect the policy or position of Full Beaker, its officers, parent, or affiliates.
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2014 Conforming & FHA Loan Limits
Mortgage loan limits for every U.S. county,
as published by Fannie Mae & Freddie Mac, and the FHA.