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Changing the Term

Another popular reason to refinance is to change the loan term, or amortization period. Perhaps the most common term refinance is for a shorter term on the note to reduce the amount of long-term interest thaf s being paid.

Look at the amount of interest paid on a 30-, 25-, 20-, 15-, and 10-year loan amount of $300,000:

Term

Rate

Interest Paid

30 year

6.50%

$382,560

25 year

6.50%

$307,500

20 year

6.50%

$236,640

15 year

6.25%

$162,960

10 year

6.25%

$104,160

As you can easily tell from the chart, the longer the term the more interest you pay. Perhaps a buyer first got a 30-year fixed rate mortgage when he or she bought a condo but now feels more comfortable making higher payments to reduce the term and the amount of interest paid by refinancing to shorter term.

Depending on how far rates actually fall during a potential refinance period, one could also reduce the term of the loan while keeping the payments about the same as they originally were. How does that work?

Let's say that someone bought his condo when rates were at relative highs, say 7.25 percent. On a $300,000 loan, that works out to $2,046 per month. A few short years later rates begin to fall, with 20-year rates dropping to about 5 */2 percent.

Refinance that same $300,000 into a 20-year loan, and the monthly payment works out to $2,063 per month. Now compare that with a 30-year loan at 5.50 percent. Although the payment is lower at $1,703 per month, the amount of interest on the 20- and the 30-year loans would be:

30 year $313,080

20 year $195,120

Yes, the borrower could have reduced his payment by a considerable amount, but the long-term interest is staggering. The borrower was comfortable making the original $2,046 per month payment. By keeping the payment yet refinancing the term, he accomplished his goal of eliminating a significant chunk of interest that would have been paid to the lender.

Another common refinance occurs when anticipating a life event, such as retirement or college plans.

A couple who wished to retire mortgage-payment-free in 15 years could refinance into a 15-year loan and watch the loan disappear right around their retirement age.

I recall a client who saw me for a refinance and had a similar life event on the horizon. In fact, he refinanced from a 15- year to a 10-year. This resulted in a relatively significant jump in his monthly payment. Rates had dropped, but not by enough to offset the increase in mortgage payment. But he had a plan.

He knew he could afford to make extra payments each month to pay off this mortgage, but he also said he “knew him self enough” that unless the monthly payment was made automatically he might not have the discipline to make those regular payments.

In this case, he had a daughter who would be college age in 10 years, and he didn't want to be saddled with college costs and a mortgage at the same time. By knocking five years off his mortgage, he knew not only that his home would be free and clear during a tested cash-flow time in his life, but that he would be able to afford to send his daughter to pretty much any college.

Another reason people refinance is to lengthen the loan term. Lengthening the term reduces the monthly payment while adding long-term interest. Sometimes things happen and it becomes necessary to reduce the monthly payment regardless of the increased interest.

Often this type of refinance is associated with a divorce situation where one spouse wants to keep the house but may not be able to afford payments on a 15-year loan.

Or perhaps someone retires or loses his or her job. The former dual-income family is now a one-income family — and will likely remain so for some time, possibly for the remainder of the loan term.

A $300,000 15-year loan at 6.25 percent comes to monthly payments of $2,572. This requires approximately $9,000 per month in income to qualify for a mortgage loan. By refinancing that $300,000 into a 30-year loan at 6.50 percent, the payment drops to $1,896 and the qualifying monthly income is reduced by $2,200 to around $6,800.

 
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