A refinancing option that can save you even more

Posted on December 13 By Peter Andrew

If the prospect of saving money is motivating you to refinance your home, you might consider shortening the term of your loan as well. But should you reduce the term (cut the length) of your mortgage when you come to refinance? It's not an easy question, because a shorter term involves a trade-off between higher monthly payments and very substantial savings in the long run. Only you can decide whether you can afford to -- or afford not to -- do it, but here is some information that could help you choose.

A straight refinance can save you loads

Freddie Mac says that people who refinanced in the third quarter of 2012 cut their mortgage rates by an average of 1.7 percent. For those with a $200,000 home loan, that translates into a savings of about $3,500 -- just over the next 12 months.

If you're concerned about the possible loss of mortgage-interest tax deductions as a result of the current fiscal cliff negotiations between the President and Congress, refinancing offers good news: The less interest you pay, the less you stand to lose if the tax code changes. But, unless you're very rich, you probably shouldn't be too worried anyway. Bloomberg reported on December 4 that the average benefit from this deduction in 2011 for a middle-income earner was just $139.

A refinance with a term cut can save you more -- like $76,000 more

That $3,500-a-year reduction in payments is not to be sniffed at. But it's relatively small compared to the long-term advantages available to those who cut their mortgage terms. Back in August, The Los Angeles Times did some math that used as an example someone with a $288,000 home loan refinanced at 4 percent. If the borrower opted for a 30-year term, her monthly payment would be $1,375. That's $521 less than she was paying under her old 6.5 percent mortgage.

But, the Times explains, were she to forgo most of that savings, and pay $1,745 a month instead, she could reduce her home loan's term to 20 years. Over the lifetime of that mortgage, she'd pay a total of $130,854 in interest. That compares with $206,984 for the same loan over 30 years -- a savings of more than $76,000. That's partly because she's borrowing the money for a shorter period and partly because mortgage rates for 15- and 20-year home loans tend to be cheaper than those for 30-year terms.

Term cuts cost -- can you afford it?

Everyone would like to take advantage of these sorts of savings, but not everyone can afford to do so. Luckily, it's easy for you to model your options using a mortgage calculator. Don't forget to take into account likely closing costs, although some lenders offer special deals on these. And, finally, remember to keep a rainy-day fund to tide you over unexpected emergencies. But if you can make the math work for you, enjoy your savings.

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