Pros and Cons of Refinancing to a Shorter Mortgage Term

The 30-year mortgage has become the standard loan product for many Americans, in part because it allows us to stretch our homebuying dollars further in a time when property prices are on the rise. However, with interest rates hitting historic lows, many homeowners are considering shorter loan terms.

If you’re thinking of refinancing into a shorter loan term, these pros and cons can help you decide which option works best for you.

Pros of a Shorter Mortgage Term

Interest rates are typically lower when you’re opting for a shorter loan term, although the spreads can vary depending on the lender and the lending climate. While that shorter rate is great, you’re still paying more in housing costs each month because of the compressed repayment period.

But the biggest pro to a shorter mortgage term is how much you can save over the long haul.

Pro No. 1: Interest Savings

If you can afford a higher payment, the interest savings may be worth it. Even if you’re facing a higher monthly payment by reducing your mortgage term, consider the interest savings over the life of your loan.

To get an idea of how substantial those savings might be, let’s compare two scenarios:

Scenario 1: You refinance your $200,000 mortgage for 30 years at a rate of 4%.

Total Interest Payment over 30 years: $143,739

Scenario 2: You refinance your $200,000 mortgage for 15 years at a rate of 3.5%

Total Interest Payment over 15 years: $57,358

Total Interest Savings with 15-year financing: $86,381

Pro No. 2: Maximize your mortgage-free years

For some homeowners, the freedom of owning a home outright outweighs the monthly expense of making a 15-year mortgage work. With a shorter mortgage term, you’ll build equity much faster. And once your home is paid off, you can redirect those funds to savings or retirement, travel, or even turn your home into an income property.

With a shorter term, you won’t have to wait until later in life to reap the benefits of living mortgage-free.

Pro No. 3: Monthly costs may be lower than you expect

Mortgage rates are exceptionally low right now, making shorter mortgage terms more feasible than ever. Depending on your current rate, you may be able to shorten your mortgage term without breaking your monthly budget.

Cons of a Shorter Mortgage Term

We’ve already highlighted the biggest con of a shorter mortgage term, and that’s having a higher monthly mortgage payment than you would with a 30-year mortgage.

Here are a few other things to consider:

Con No.1: Higher cost = Higher risk

While shorter loan terms are considered a lower risk for lenders and investors, they may represent a higher risk for homeowners based on month-to-month affordability. Since shorter terms mean a higher monthly payment, you’ll want to consider your income and employment stability.

That said, if the higher payment is well within your range of affordability, a shorter loan term might be the best choice.

Con No. 2: Stretching Affordability Limits

When it comes to refinancing, lenders are used to seeing payments go down based on interest rate reductions. This can mean less stringent underwriting requirements. Or, in the case of some loan products—like the VA Interest Rate Reduction Refinance Loan—income and asset verification may be waived entirely.

If you’re refinancing into a shorter loan term, there’s a good chance your payment will increase, even slightly. When your payment goes up, you may need to provide full verification documents, like pay stubs and other financial information, so an underwriter can make sure the new payment isn’t too high.

Con No. 3: Less Budget for Savings

The cost savings associated with a 15-year mortgage, while substantial, are all long-term. Your monthly budget is the real key to deciding whether a shorter mortgage term is feasible.

When considering the affordability of a higher mortgage payment, ask yourself these questions:

• Does the new payment take up more than 30 percent of my pretax monthly income?
• Can I still afford to save about 20 percent of my pretax income after covering other expenses?

Answering “no” to both of these questions may signal that the payment on a 15-year mortgage is just too high. If shortening your loan term puts you in a house-poor position for the foreseeable future, the risks may outweigh the benefits.

As a homeowner, it’s essential to have reserve funds tucked away for maintenance, repairs and emergencies. Otherwise, you may be forced to accrue more high-interest debt when your savings fall short. And saving on mortgage interest just to pay interest elsewhere doesn’t make sense.

Those who can afford a shorter mortgage term should consider it for the interest savings alone. For others, the higher payments associated with shorter loan terms may stretch their monthly budget too thin.

Ultimately, these financial considerations, along with your personal lifestyle goals and priorities, can help you determine what’s right for you.