Typical home mortgages are approved with a thirty year loan term, so you’ll be paying the mortgage on your house for the next thirty years. That is a long financial commitment, but it’s worth it because it’s also an investment. As you pay down the mortgage you increase the equity. Over time that equity really starts to add up and eventually you can get a loan for the equity and use it for other things. The downfall to all of this is that you will be paying interest on the loan for the next thirty years. A house that cost $150,000 to buy originally may double in price by the time the mortgage is actually paid off. So you get a loan for $150,000 and pay $150,000 in interest. While these numbers are very basic, you get the idea. So the question that’s worth asking is are there ways to save money on interest? The answer is absolutely. There aremultiple ways. Some people get a loan refinance and shorten the loan terms, saving money in the long run. Here are a few things you should know before you jump in.
How a Shorter Term Loan Refinance Can Help
When you get a thirty year loan you are given an amortization schedule. This schedule shows how much you’ll be paying in interest every month until the loan is paid off. The initial payments are paying much more on interest than the payments further on. After a few years, your payments will start to impact the principle and you’ll see the loan begin to decrease. With a fifteen or twenty year mortgage, the amortization schedule shows that the principle is impacted much sooner. In our example of the $150,000 mortgage, with a loan term of 30 years at an interest rate of 5%, the homeowner spends about $140,000 in interest, in addition to the loan amount. With a 15 year loan at the same interest rate, the interest paid is closer to $60,000. As an added bonus, many lenders reduce the interest rates on short term loans, so by switching to a 15 year loan you may see it reduced by up to a point, sometimes more and sometimes less.
In addition to the thousands that you can save on a shorter loan term, you will also pay off the mortgage in half the time. 15 years as opposed to 30 years is a tempting scenario. Many homeowners choose this so they can be free and clear on their mortgage and use the monthly payments for other things. Some choose vacations, others choose to widen their investment portfolio, and some use it for a rainy day fun. Whatever your reasons, freeing up a mortgage payment every month can seriously reduce your financial burden.
Fees and Expenses
If you’re able to get a home at a 15 year term on your original loan, great, but much of the time homeowners refinance to get those shorter terms. It’s important to use a refinance calculator and crunch some numbers before you refinance. On a first time loan it’s a no-brainer; you are going to save money in interest. However, on a loan refinance there are factors that come into play that will affect whether or not you’ll save money. Some of these factors include the closing costs and fees associated with the loan refinance and the length of time you’ve had the loan you are refinancing.
Refinancing can be expensive, typically in the thousands, which means up front you have to put out a couple grand before you feel any effects of the refinance. You won’t recoup this loss until you’ve saved enough money in interest or on mortgage payments to counteract what was originally spent. So if you had a thirty year loan and switch to a fifteen year loan, your immediate expenses are going to counter the benefits of the switch. In some cases, it’s not worth it. A refinance calculator will help you determine whether or not it will be worth it for you. The second thing you really need to look at is how long you’ve had the original loan.
If you’re switching to a fifteen year loan after you’ve had the original loan for fifteen years, there is no guarantee you’ll save money. Depending on the terms of the new loan, you may be in the same boat you’re in now, only you’ll have paid thousands of dollars to get there. So pay close attention to the loan terms and make sure you’ll see a financial benefit before you sign.