When to Refinance a Home Mortgage: Now, Later, or Never?

Posted on October 28th, 2020

Mortgage Q&A: “When to refinance a home mortgage.”

With mortgage rates at or near record lows, you may be wondering if now is a good time to refinance. Heck, your neighbors just did and now they’re bragging about their shiny new low rate.

The popular 30-year fixed-rate mortgage slipped to 2.80% last week, per Freddie Mac, well below the 3.75% average seen a year ago, and much better than the 4-6% range seen years earlier.

Historically, mortgage interest rates have never been lower, making a mortgage refinance a veritable no-brainer for many homeowners out there.

In other words, there’s a good chance you won’t be holding off from refinancing because interest rates are too high (unless you just recently refinanced).

But even if you did, there’s a possibility it could make sense to refinance a second time.

Should I Refinance My Mortgage Now?

should i refinance

  • Consider your current interest rate relative to today’s available rates
  • Along with required closing costs and how long it will take to break even
  • Think about how long you plan to keep the mortgage/property
  • And any other factors like removing mortgage insurance or shortening your loan term

Well, the answer to that question depends on a number of factors that will be unique to you and only you.

First, what is the interest rate on your existing mortgage(s)? Is it higher or lower than current mortgage rates?

If it’s higher, how much higher? If it’s lower, is your current loan adjustable? Or do you want to refinance for another reason, perhaps to tap equity?

Once you’ve got those basic questions answered, let’s talk about the new loan. What will the rate and closing costs be on the new mortgage?

Have you started shopping rates yet? Do you even know if you qualify?

How long do you plan to keep this new mortgage? What about the house? Are you sticking around for a while?

Assuming you’re still here, it might be a good time to take a look at a common scenario to illustrate the potential savings of a refinance.

Let’s look at a quick home refinance example:

Loan amount: $200,000
Current mortgage rate: 4.25% 30-year fixed
Refinance rate: 2.75% 30-year fixed
Closing costs: $2,500

The monthly mortgage payment on your current mortgage (including just principal and interest) would be roughly $984, while the refinanced rate of 2.75% would carry a monthly P&I payment of about $816.

That equates to savings of roughly $168 a month if you were to refinance. Not bad. But we aren’t done yet.

Now assuming your closing costs were $2,500 to complete the refinance, you’d be looking at about 14 months of payments, give or take, before you broke even and started saving yourself some money.

Yes, you need to consider the cost of the refinance too…

So if you happened to refinance again or sold your home during that window, refinancing wouldn’t make a lot of sense.

In fact, you’d actually lose money and any time you spent refinancing your mortgage would be wasted as well.

But if you plan to stay in the home (and with the mortgage) for many years to come, the savings could be substantial. Just imagine saving $168 for 200 months or longer.

This “break-even” point is key to making your decision, at least financially speaking.

You also need to consider whether it makes sense to buy down your interest rate by paying points, which will increase the time to this break-even point.

For example, those who paid upfront points on their refinance a year ago might be kicking themselves, knowing they’ll benefit from a subsequent refinance thanks to today’s even lower rates.

So sit down and determine your future housing plans before you decide to refinance to determine if it’s the right move.

If you don’t know what your plan is for at least the next few years, you may want to hold off until you do.

[The refinance rule of thumb.]

How Long Have You Had Your Existing Mortgage?

when to refinance

  • You also have to consider how long you’ve had your current home loan
  • This can play a big role in determining whether a refinance makes sense
  • Take note of how much it has been paid down since that time
  • And how much of each payment is going toward interest

Here’s another consideration. If you’ve already paid down your mortgage substantially, it might not make sense to refinance, assuming you want to pay the thing off.

Even if rates are super low, as there’s a good chance you’ll pay more interest overall if you “reset the clock” and start your full loan term over again. But this isn’t always the case.

To determine if a refinance is still the right move, get your hands on an amortization calculator.

That way you can see what you’ll pay in interest if you keep your mortgage intact versus what you’ll pay in interest with the new mortgage, factoring in what you’ve already paid on the old mortgage.

You can also use my refinance calculator to plug in all the pertinent numbers, including what we discussed above, to get a quick answer.

If your calculations reveal that you’ll pay more interest over the entire term of the refinance mortgage, there’s an easy strategy to reduce both interest paid and the term of the new mortgage.

Simply make the same monthly mortgage payment you were making before the refinance, with the excess going toward principal each month.

This will shorten the loan term and could save you a lot of money. I explain this method on my mortgage payoff tricks page, which you can read about in more detail.

If you can afford it, you may also want to look into shortening the loan term by going with a 15-year fixed mortgage.

For example, if you’re already 10 years into your 30-year mortgage, reducing the term to a 15-year fixed will ensure you don’t extend the aggregate term.

And with mortgage rates so low, you may be able to retain your low monthly mortgage payment and pay the mortgage off even earlier than expected.

Lock in a lower rate.

Also, 15-year mortgage rates are lower than those on the 30-year fixed.

Other Mortgage Refinance Considerations…

  • Even if interest rates are comparable to what you already have
  • It could make sense to refinance out of an ARM or an interest-only loan
  • The same is true if you want to get rid of mortgage insurance
  • Or if you’d like to consolidate two mortgage loans into one

If you’re currently in an adjustable-rate mortgage, or worse, an option arm, the decision to refinance into a fixed-rate loan could make a lot of sense.

Even if the monthly savings aren’t tremendous, getting out of a risky product and into a stable one could pay dividends for years to come.

Or if you have two loans, consolidating the total balance into a single loan (and ridding yourself of that pesky second mortgage) could result in some serious savings as well.

You’ll have one less mortgage to worry about and ideally a lower combined monthly payment.

The same might be true if you have mortgage insurance and want to get rid of it. Many homeowners will execute an FHA-to-conventional refinance to drop MIP and reduce monthly payments once they’ve got some equity.

Additionally, you might be able to get your hands on a no cost refinance, which would allow you to refinance without any out-of-pocket costs (the rate would be higher to compensate).

In this case, if the rate is lower than your existing rate, you start saving money immediately.

As mentioned earlier, a cash-out refinance could also contribute to your decision to refinance if you are in need of money and have the necessary equity.

Heck, with mortgage interest rates this low you could even make the argument to tap equity and invest it elsewhere for a better return.

Again, you’ll want to aim for a lower rate and cash back, but there could be a scenario where borrowing from your home is the best deal, even if you don’t save much or anything mortgage payment-wise.

This is really just the tip of the iceberg. There are countless reasons to refinance your home loan, including many seemingly unconventional ones you may have never thought of.

Whatever the reason, be sure to put in the time (and the math) to ensure it’s a good decision for you and not just the bank or a loan officer pushing you to do it!

Lock in a lower rate.

Source: thetruthaboutmortgage.com

Why Are Mortgage Rates Different?

Mortgage rate Q&A: “Why are mortgage rates different?”

Why is the sky blue? Why are clouds white? Why won’t your neighbor trim their tree branches?

These are all good questions, and ones that often puzzle even the most savvy of human beings.

First things first, take a look at how mortgage rates are determined to better understand how banks and mortgage lenders come up with interest rates to begin with.

From there, you’ll need to consider why mortgage rates are different for consumer A vs. consumer B.

No One Size Fits All for Mortgage Rates

why mortgage rates different

  • Mortgages are kind of like snowflakes in that no two are exactly the same (not really)
  • The subject property and the borrower will always have unique characteristics
  • As such risk on the underlying loan will vary and so too will the interest rate received
  • Lenders also price their mortgages differently so even identical scenarios can result in variable pricing

Mortgages are complicated business, and there certainly isn’t a one-size-fits-all approach in this industry.

First off, there are thousands of different banks, lenders, and credit unions that offer home loans, some of them entirely unique and proprietary.

These companies compete with one another to offer the lowest rate and/or the best customer service.

The well-known names might offer higher rates in exchange for their perceived trust and familiarity.

Meanwhile, the smaller guys might offer rock-bottom rates to simply stay in contention with the big players.

Along with that, every loan scenario is different (just like a snowflake), and must be priced accordingly to factor in mortgage default risk (risk-based pricing).

Simply put, the higher the risk of default, the higher the mortgage rate. But that’s just the tip of the iceberg.

There also promotional rates, such as mortgage rates that end in .99%, and innovative marketing products like UWM’s Exact Rate that lets brokers offer strange rate combinations, including 2.541% or 2.873%.

So the possibilities truly are endless these days when it comes to different mortgage rates.

Mortgage Rates Vary Based on the Loan Criteria

  • Mortgage lenders make a lot of assumptions when advertising rates
  • Your particular loan scenario may be quite different than their hypothetical loan
  • You have to take into account the many pricing adjustments applicable to your mortgage if it doesn’t fit inside that box
  • These adjustments have the potential to greatly increase or decrease your interest rate

Mortgage rates don’t exist in a bubble – the parts affect the whole.

Banks and lenders start with a base interest rate (par rate) and then either raise it or lower it (rarely) based on the home loan’s criteria.

There are loan pricing adjustments for all types of stuff, including:

· Loan amount (conforming or jumbo)
· Documentation (full, stated, etc.)
· Credit score
· Occupancy (primary, vacation, investment)
· Loan Purpose (purchase or refinance)
· Debt-to-Income Ratio
· Property Type (single-family home, condo, multi-unit)
· Loan-to-value / Combined loan-to-value

The more you’ve “got going on,” the higher your mortgage rate will be. And vice versa.

In short, an individual purchasing a single-family home with a conforming loan amount, 20% down payment, and a 800 FICO score will likely qualify for the lowest rates available.

Conversely, the individual requesting cash out on a four-unit investment property with a 640 FICO score will likely be subject to a much higher rate, assuming they even qualify.

And again, rates will vary from lender to lender, so it’s a multi-layered situation.

I’ve already covered a few related topics, including why mortgage rates rates are higher for condos and investment properties.

Mortgage rates also tend to be higher on jumbo loans and refinance transactions, especially those involving cash-out.

Advertised Mortgage Rates Are Best Case Scenario

  • Mortgage rates on TV and online are usually best-case scenario
  • They are intended to be super attractive to lure you in and snag your business
  • When the dust settles your interest rate might look nothing like what you saw advertised
  • This is why it’s important to shop around and better understand how risky your particular loan is

You know those mortgage rates you see on TV or on the Internet?

Those assume you’ve got an owner-occupied single family home, a perfect credit score, a huge down payment, and a conforming loan amount.

Not to mention a newborn golden retriever with an unmatched pedigree.

Most people don’t have all those things, and as a result, they’ll see different mortgage rates. And by “different,” I mean higher.

How much higher depends on all the factors listed above.  So take the advertised rates you see with a huge grain of salt.

Also, take the time to shop your home loan with different lenders, and in the process, get to better understand your risk.

Find out what lenders are docking you for and take steps to fix those things if you want the lowest rates available.

Do Mortgage Rates Vary By State?

  • Yes, they sure can! You might get a lower rate in California vs. Nebraska
  • Depending on lender appetite for a certain geographic region
  • Rates may vary from state to state, or even in certain counties
  • Make sure the lender you use offers the best pricing for the state in which you reside

One last thing. I’ve been asked if mortgage rates can vary from state to state, and the answer is actually YES. In fact, they can even vary by county in some cases.

As you can see from the image below, some states tend to have lower average mortgage rates for one reason or another.

States Lowest Average Mortgage Rates

This list is from February 2019, when the average rate for the 30-year fixed was 4.84% nationwide, per LendingTree.

While no state offered an average rate below 4.74% or above 4.96% (pretty narrow range), there was some divergence by locality.

California led the nation with an average rate of 4.74%, followed closely by the 4.75% average seen in New Jersey and the 4.76% average found in both Washington and Massachusetts.

Nothing earth-shattering, but still different nonetheless.

But it might not be for any one reason, such as a higher default rate in state X or fewer natural disasters in state Y. Or more regulations in another state.

It could be more to do with the fact that lenders want to increase their business in a certain part of the country, and thus they’ll offer some sort of pricing special or incentive to drive rates down in say California.

So you might see a rate sheet that says .50% rebate state adjustment for loans in CA and FL, for example. This will give them a competitive advantage in those regions.

How about states where mortgage rates tend to be slightly higher, such as New York, Iowa, and Arkansas, which averaged 4.96%, 4.93%, and 4.92%, respectively?

States Highest Average Mortgage Rates

It’s possible you might see a pricing adjustment of say .25% for one of these states that may drive the interest rate up somewhat.

In other words, rates can be priced both higher or lower depending on the state where the property is located.

Of course, if this results in unfavorable pricing you can just move on to a different lender that doesn’t charge more for the state in question.

All the more reason to shop around, compare mortgage rates online, and speak with a mortgage broker or two.

Once you’ve done that, check mortgage rates with your local bank or credit union as well.

Don’t be one of the many who obtain just one mortgage quote because you may wind up paying too much.

Read more: What mortgage rate can I expect?

Lock in a lower rate.

Source: thetruthaboutmortgage.com

Buying a Home in 2021? 11 Tips to Get It Done!

If you’ve yet to enter the housing market, but are thinking of buying a home in 2021, there’s a lot you need to know.

As I once pointed out, this isn’t your older sibling’s housing market. Not just anyone can get a mortgage these days. You actually have to qualify. But we’ll get to that in a minute.

Let’s start by talking about home prices, which have soared in recent years. The good news is mortgage rates remain very low, and may even break new record lows this year, which can keep affordability within reach.

1. Prepare for More Sticker Shock

Yes, if you’re prepping to buy a home in 2021, expect to be shocked, and not in a good way. At this point in the cycle, home prices have eclipsed old all-time highs in many parts of the country.

And even if they haven’t yet, there’s a good chance you’ll be paying more than the Zestimate or Redfin Estimate for the property in question due to limited inventory and strong home buyer demand.

The bad news for renters is home prices are expected to rise another 10% this year, so things are just getting more and more expensive.

In short, expect to shell out a lot of dough if you want a home in 2021, and that could often mean paying over asking price, even if the original list price seems high.

2. Get Pre-Approved for a Home Loan Early

Speaking of that home being out of your price range, you may want to get pre-approved with a bank or mortgage lender ASAP.

First off, real estate agents won’t give you the time of day without one, especially in a red-hot market.

And secondly, if you don’t know how much house you can afford, you’re basically wasting your time by perusing listings and going to open houses.

This is especially true if the homes you’ve got your eye on are consistently going above asking since you’ll need even more purchasing power.

It’s not hard or all that time consuming to get a mortgage pre-approval, and it’ll give you more confidence and perhaps make you more serious about finally making the move.

Tip: Look for an online mortgage lender that lets you generate a pre-approval on the fly in minutes (and know you don’t have to use them if and when you proceed with a purchase!).

3. Check Your Credit Scores and Put Away Your Credit Cards

While you’re at it, you should check your credit scores (all 3 of them) and determine if anything needs to be addressed.

As I always say, credit scoring changes can take time, so give yourself plenty of it. Don’t wait until the last minute to fix any errors or issues.

And while you’re addressing anything that needs more attention, do yourself a favor and put the credit cards in the freezer (or somewhere else out of reach).

Lots of spending, even if you pay it back, can ding your scores, even if just momentarily. It can also increase your DTI ratio and limit your purchasing power. Ultimately, bad timing can create big headaches.

Additionally, pumping the brakes on spending might give you a nice buffer for closing costs, down payment funds, moving costs, and renovation expenses once you do buy.

4. Housing Inventory Will Be…Limited

It’s the same story in 2021 as it was in 2020, 2019, 2018, and heck, even as far back as 2012. There’s really been a lack of inventory since the housing market bottomed because homes were never for sale en masse.

During the prior housing crisis, borrowers got foreclosed on or deployed real estate short sales to move on, and banks made sure all that inventory never flooded the market.

Now we’ve got would-be sellers with nowhere to go, thanks to the massive price increases realized in the past few years. It’s hard to move up or downsize, so a lot of folks are staying put. That means less choice for you.

While we saw an uptick in inventory in 2019, it appeared to be short-lived and now housing supply is at an all-time low!

With near-record low interest rates and lots of Americans hitting the ripe first-time buyer age of 34, expect competition to intensify.

Again, this supports the argument of being prepared early so you’re ready to make an offer at a moment’s notice!

5. That Home Might Be a Fixer

You probably don’t have the same skill set as Joanna and Chip Gaines, but you might still wind up with a fixer-upper thanks to those inventory constraints. And that’s totally okay.

What I’ve learned from buying real estate is that you’ll typically never be content with the upgrades previous owners or developers make, even if they were super expensive and high quality. So why pay extra for it?

There’s a good chance you’ll want to make the home yours, with special touches and changes that distance yourself from the previous owner.

Don’t be afraid to go down that road, but also know the difference between superficial blemishes and design challenges, and even worse, major problems.

Especially this year, watch out for money pits that sellers can finally unload because real estate is just so very hot.

Those properties that could never sell may finally find a buyer, and you might not want that buyer to be you.

6. You May Have to Fight for It

What’s even more annoying is that you may have to fight to get your hands on the few properties that are out there, depending on the housing market in question.

In popular metros, bidding wars will still take place, and they even become the norm again as they were in previous years.

If the property is popular, there will always be someone willing to outbid you for that home they just must have. This is another reason why the fixer can be a winner, the hidden gem if you will.

That being said, it’s okay to pay more than asking (or even the fully appraised value), just keep in mind that there are plenty of fish in the sea.

Well, perhaps not plenty right now, but there’s always another opportunity around the corner.

Stay poised and don’t let your emotions get the best of you. Like anything else, it’s okay to walk away. Trust your gut.

7. Still Negotiate with the Seller

Just because 2021 will be a seller’s market once again, at least in popular markets, doesn’t mean you can’t negotiate. You can still get into a bidding war, win the thing, and then inspect the heck out of the house.

Inspections are key to determining what will need to be addressed once the home changes hands, and what the seller will need to do to compensate you for those issues.

If you don’t get a quality inspection (or two), you will have a difficult time asking for credits for closing costs or even a lower purchase price. Take it very seriously, the return on investment can be staggering.

Also know that in some markets, buyers may have the upper hand in 2021. Not all real estate markets are red-hot anymore, so you might be able to bid below asking and still get money for repairs.

Lock in a lower rate.

8. Do Your Mortgage Homework

While you might have your hands full with an overzealous real estate agent, it’s important not to neglect your mortgage homework.

Mortgages are often just mailed in, with little attention given to where they are originated.

Your real estate agent will have their preferred lender that you “really should consider using because they’re the best,” but you don’t have to use them or even speak to them.

I’ll typically say get a quote from them as a courtesy to keep things amicable, and to appease your agent, but also shop around with other banks, credit unions, lenders, and mortgage brokers.

At the same time, think about how you want to structure the mortgage, including down payment, loan type (FHA or conventional), and loan program.

The 30-year fixed isn’t always a no-brainer, though right now it’s a tough argument to go against it.

There are other loan programs that can make sense too, such as the 5/1 ARM, which often get swept under the rug. Make the choice yourself.

9. Expect a Very Good Mortgage Rate

If you’ve done your homework and are in good financial shape, you should be able to get your hands on a very low mortgage rate in 2021.

In fact, mortgage interest rates are historically amazing at the moment and could even reach new depths depending on what transpires this year.

Once again, the 2021 mortgage rate forecast looks excellent, so they may stay put for awhile longer or even hit new all-time lows.

In terms of financing, it’s still a great time to buy a home. Consider that the silver lining to an otherwise pricey and competitive housing market.

Of course, with home prices creeping higher and higher, even a low interest rate may not be enough to offset that growing monthly payment.

So always make time to shop to ensure you get the best rate and the lowest fees, even if financing is on sale.

Just because rates are cheap doesn’t mean you should just accept what’s thrown in front of you. Still complain, still negotiate, still ask for more!

10. The Best Time to Buy Might Be Later in the Year

Before you get too excited, or worried that time is running out, it might actually be in your favor to slow play this one.

Per Zillow, the best time to buy a home may be in late summer, including the months of August and September.

Basically, you’ve got the slow, cold months at the start of the year where there isn’t much inventory, followed by the strong spring housing market where everyone and their mother wants to buy.

Then you get a lull and perhaps even a dip in home prices during summer, which could be an attractive entry point.

You might even get lucky and snag a price cut with a lot less competition while other prospective buyers are on vacation.

That being said, get pre-approved NOW and set up your alerts for new listings ASAP and just be ready to pounce whenever.

11. Are You Sure You Want to Buy a Home?

Lastly, take a moment to ensure you actually want to buy a home as opposed to continuing to rent.

I constantly hear the old “throwing away money on rent” line and it never gets old. Then I proceed to fantasize about renting with not a care in the world.

Are you sure you’re throwing away money on rent? Renting can be pretty awesome.

You don’t pay property taxes, homeowners insurance, HOA dues, PMI, or mortgage interest. And you can leave whenever you want. That sounds like a sweet deal too.

Oh, and if anything goes wrong, you can just call your landlord or property management company.

With a home, the problem is yours, and yours alone to deal with. Broken water heater? You’re paying thousands out of pocket, not the landlord.

Consider the Effects of COVID-19

One extra thing to consider given the ongoing COVID-19 pandemic that reared its head last year.

As you might expect, it’s making the home buying and selling process a bit more complicated than usual, despite companies learning to adapt.

For example, home sellers are more reluctant to hold open houses or let anyone in their home, and prospective buyers are probably also a bit apprehensive entering a stranger’s house.

But it’s still very important to get a good look at a property you’re considering buying. The same goes for the home inspection and the home appraisal.

Both should still be taken very seriously, even if more difficult to complete.

A home purchase doesn’t necessarily have to be put on hold due to COVID-19, but it might require more thought given the increased uncertainty with the economy, demographic shifts (city vs. suburban living), and so on.

Also, think before you make a complete lifestyle change like moving out of the city and into the country, just because it’s on-trend. You might look back in a year or two and say what was I thinking?!

Ultimately, you should always give a home purchase a ton of thought though, so for me not much has changed.

Read more: When to look for a house to buy.

Lock in a lower rate.

Source: thetruthaboutmortgage.com

20-Year vs. 30-Year Mortgages: Get a Lower Rate?

It’s time for a new mortgage match-up.

Since paying down the mortgage early seems to be so en vogue these days, it makes sense to compare “20-year mortgages vs. 30-year mortgages.”

The most common type of mortgage is the 30-year fixed. It amortizes over 30-years and the mortgage rate never changes during that time.

Each mortgage payment is the same every month, so there isn’t any fear of interest rates resetting higher and pushing a homeowner toward foreclosure.

It’s also very affordable relative to other loan programs because of the ultra-long amortization period. Pretty straightforward, right?

For this reason, it holds a near-90% share of the home purchase market, and accounts for over three-quarters of all home loans, including refinances. It is the gold standard.

This simplicity and safety explains its popularity, but that doesn’t mean it’s the perfect home loan.

After all, they take a full three decades to pay off, and with first-time home buyers sometimes entering the market between the ages of 30 and 40, one could easily carry their mortgage into retirement.

Fortunately, there are other options with different loan terms to consider.

How a 20-Year Fixed Mortgage Works

20-year fixed mortgage

  • Just like the more common and popular 30-year fixed mortgage
  • The interest rate never changes during the entire loan term
  • But the 20-year mortgage term is a full decade shorter
  • This results in less interest paid in exchange for a higher monthly payment

The 20-year fixed mortgage is a pretty simple loan program, just like it’s much more popular cousin the 30-year fixed.

They’re actually no different other than the fact that the mortgage term is 10 years less.

Both come with an interest rate that never changes during the loan term, making it a safe choice for someone fearful of a rate adjustment on an ARM.

The borrower who opts for a 20-year fixed also gets to pay off their home loan a decade earlier.

Aside from owning your home much faster, you’ll also save on interest over the shorter repayment period.

Another benefit is that the interest rate is sometimes a bit cheaper as well, which results in a one-two punch.

20-Year Mortgage Loans Can Save You a Lot of Money

20-year fixed

  • It’s not very economical to pay back your mortgage over 30 years
  • Some will even argue that 20 years is too long as well
  • You pay a ton of interest over such an extended period of time
  • But not everyone can afford the higher monthly payment tied to shorter-term mortgages

When it comes down it, 30-year mortgages have some serious drawbacks, with the most obvious one being the long amortization period.

They also come with the highest interest rates relative to other loan programs. Yes, you pay a premium for the convenience of a fixed interest rate over three decades.

And since the mortgage takes so very long to be paid off, a lot more interest is paid and it takes forever to build home equity.

Think of it this way. If you borrowed money from a friend and asked to pay it back over 30 years, they would probably say no. Only mortgage lenders seem willing to do this.

If by chance they agreed, they’d want to charge you a higher rate of interest. And because you’d be paying it back so slowly, you’d pay a lot more interest over that time.

Assuming your loan amount is large, perhaps a jumbo mortgage, it could be the difference of many thousands of dollars versus a mortgage with a shorter term.

Consider a Shorter-Term Mortgage Like the 20-Year Fixed

  • A 20-year fixed greatly reduces the amount of interest due
  • And results in a home that is free and clear 10 years earlier
  • The monthly payment may not even be much more expensive
  • Perhaps just 1.2 to 1.3X that of a 30-year fixed depending on rate

So what are homeowners to do? Well, the most common solution to this ”problem” is to look at a shorter-term home mortgage instead, such as a 20-year loan.

While the 15-year fixed is the most common alternative, it comes with its own drawback, namely a much higher monthly mortgage payment that most home buyers can’t afford, especially first-timers.

In other words, not every homeowner can just say, “I want to pay my mortgage off faster” and switch to a 15-year fixed or 10-year fixed mortgage.

It gets very expensive. Nor can most first-time home buyers qualify at the higher payment.

Fortunately, there are mortgage product options in between, with the most common being the 20-year fixed mortgage.

A 20-year mortgage sheds 10 years off the typical loan term, and results in much less interest paid throughout its duration. The mortgage payments are also relatively manageable.

Tip: There are 20-year FHA mortgages and VA loans available if you don’t have a lot of down payment money but still want to pay your mortgage down fast.

Let’s look at an example of the 20-year fixed to illustrate the savings:

$200,000 Loan Amount 30-Year Fixed 20-Year Fixed
Mortgage Rate 4% 3.75%
Monthly P&I Payment $954.83 $1,185.78
Payment Difference $230.95
Total Interest Due $143,738.80 $84,587.20
Interest Difference $59,151.60

20-Year Mortgage Rates Are Cheaper

  • You should receive a lower mortgage rate if you opt for a 20-year fixed mortgage
  • How much lower will vary by bank/lender and how much you shop around
  • Expect a discount somewhere around .125 to .25% vs. the 30-year fixed
  • But be sure to put in the time comparison shopping

As you can see from the example above, 20-year fixed mortgage rates aren’t much different than 30-year fixed mortgage rates, though the 20-year mortgage does tend to price a little bit lower than the 30-year fixed.

That lower interest rate can save you even more over the shorter term of the 20-year loan.

Overall, I’d say that 20-year mortgage rates price about a .25% below a comparable 30-year fixed. So 3.75% instead of 4%, or 3.5% instead of 3.75%. You get the idea.

It does depend on the bank or credit union in question. Some may price the loan products fairly similarly, with the only difference reduced closing costs (or fewer discount points).

They’re definitely going to be higher than rates on a 15-year fixed, but you should save some money versus the 30-year fixed.

Of course, you have to consider your property type, credit score, down payment/home equity, other various borrower attributes, and whether we’re talking about conforming mortgages or jumbo mortgages.

Anyway, in our example above the homeowner with the 30-year mortgage pays about $230 less each month, despite the higher mortgage rate. Yes, their monthly mortgage payment would be significantly lower.

But the 20-year fixed results in interest savings of nearly $60,000 over the life of the loan! This borrower would also own their home free and clear an entire decade earlier.

Doesn’t 20 years sound a lot more reasonable than 30? You can actually see the light at the end of the tunnel and pay off the mortgage before your hair turns gray.

This shorter term can be pretty beneficial, especially if you plan to retire soon and anticipate being on a fixed income.

Or if you want to build equity and buy a move-up property in the near future, using the proceeds for the down payment.

The 20-year fixed is also a good alternative because you won’t break the bank making your mortgage payment each month.

It’s a nice middle ground between 30 years and 15 years, and highlights the importance of comparing mortgages across the whole spectrum.

But again, the monthly payment will be higher than the 30-year payment, which could stretch you thin or limit what you can afford if you’re buying an expensive home.

Tip: When obtaining a mortgage pre-qualification, ask your loan officer if you make enough to support 20-year fixed payments. Or simply do the math yourself with the help of a mortgage calculator.

Go With a 20-Year Fixed Mortgage to Stay on Course

  • If you have a 30-year mortgage and want to refinance to a lower rate
  • Consider switching to the 20-year fixed instead of getting another 30-year term
  • This way you won’t restart the (amortization) clock on your mortgage
  • You can save even more interest and pay off your home loan a lot faster

If you’re currently in a 30-year fixed, and don’t want to reset the mortgage clock during a mortgage refinance, consider a move to a 20-year fixed to stay on course without even paying more each month.

For example, if you’ve already been paying down your mortgage for five years, you won’t necessarily want to take on a fresh 30-year mortgage if your goal is to pay off your loan.

Because mortgage rates are so low at the moment, you may be able to refinance from a 30-year to a 20-year fixed mortgage and still lower your monthly payment.

Also keep in mind that there are other loan types outside the 15, 20, and 30-year options.

Some banks even allow you to choose your own mortgage term, whether it’s a 17-year fixed or a 24-year fixed.

So be sure to look at all available home loan options to determine which makes the most sense financially for your unique situation.

Also ask yourself why you want to pay the mortgage off sooner rather than later. There may be a better place for your money.

Read more: 30-year fixed vs. 15-year fixed.

Don't let today's rates get away.

Source: thetruthaboutmortgage.com