You may still be paying too much on your mortgage.
If you are like many people, you are thinking, “I’ve been paying on my 5% mortgage for five years. I don’t want to go back to a 30 year loan. I’m trying to get this place paid off.”
This is a reasonable concern—but it is not a good reason pass up the low mortgage rates we have today. If your goal is to own your home free and clear, you should know about some often-overlooked ways to leverage the benefits of a refinance. I’ll give you a few of them.
Select a shorter term mortgage
Many homeowners opt to refinance with a term of 15 years, or even shorter. Although the rate is lower, the higher payment may be uncomfortable. If you owe $300,000 on a 5% loan you have had for 5 years, your payment now is $1,753. Dropping your rate to 2.99% for a 15 year loan will save you money—but your monthly payment will be $2,070—$316 higher .
Pay a little more each month
There are other ways to get your mortgage retired ahead of time painlessly. First, you should be aware that you are allowed to pay more than the amount stated on your mortgage statement. Any excess amount is automatically applied to the principal balance. Paying “extra” will shorten the term of your loan. If you have a $300,000 mortgage at 3.75%, your monthly payment (not including taxes and insurance) is $1,389.35. That will pay off your loan in exactly 30 years. Adding just $100 a month to that payment will cut the term of your loan to 26 years, 7 months. That’s 3 years, 5 months less to be paying your mortgage.
Lower the mortgage rate, but not the payment
Many homeowners refinance into a lower rate but choose not to change their monthly payment. Reducing your rate to $3.75% from 5%, for instance, will drop your monthly payment by $364 a month if you have the loan I described above. Part of the reason your payment drops so much, however, is because of “reamortization:” increasing the term of your loan to 30 years.
Whatif you keep paying $1,753 a month, but with the lower rate? Your loan will be paid off in just over 20 years—five years sooner than with your old loan.
Create a “debt snowball” with your new mortgage
There is another strategy you should consider. If you have any consumer debt—credit cards, car loans, student loans—you can create a “debt snowball” by using your monthly refinance savings to retire those debts. As you pay off each obligation and no longer have to make its payment, you add to the payment you make on the next one, until they are all retired. If you are paying, say, $600 a month on consumer debts and you free up that money to apply to your mortgage, you will be able to increase your monthly mortgage payment by a total of $964 a month without affecting your household budget. Put another way, by refinancing and applying your monthly savings to debt retirement, you will free up close to $1,000 a month—without affecting your lifestyle a single penny’s worth.
Now you’ll be able to make a payment of $2,353 a month.
How does having a free-and-clear home in 13 years, six months sound to you?