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Real Estate Law Blog

Mortgage Refinance - Shortening Loan Terms

Mortgages
Shortening Loan Terms
 
The New York Times
By VICKIE ELMER
Published: June 1, 2012
·         
LOW interest rates are making it easier for homeowners to reduce their  mortgage  payoff  times considerably.
 
Almost a third of those who refinanced in the first quarter cut the duration of their mortgages to 15 or 20 years from 30, according to a recent refinancing report by Freddie Mac. The 31 percent who shortened their terms represented the second-highest level since 2002, when 35 percent took out shorter-term loans, the data showed. In the fourth quarter of 2011, 34 percent had reduced their mortgage terms. The all-time high occurred in 1992, with 42 percent refinancing into shorter mortgages.

“Historically low rates and an average three-quarters of a percentage point difference between 30- and 15-year mortgage fixed-rate mortgages are important drivers for moving to a shorter term,” Frank Nothaft, Freddie Mac’s chief economist, said in an e-mail.

The 15-year fixed-rate loan averaged 2.97 percent nationwide, according to Freddie Mac’s latest survey, released on Thursday. That was the lowest rate since the agency started keeping track of that loan in 1991. The 30-year loan also set another record low, at an average 3.75 percent.

The switch to shorter loan terms may also be part of a trend to deleverage and reduce debt levels, which started in the economic downturn. “People are taking control of their own equity — they’re paying it down quickly,” said Michael McHugh, the president of Continental Home Loan and president of the Empire State Mortgage Bankers Association.
Some people decide to refinance into a shorter mortgage after they have been promoted at work, said Kate McCue, an executive vice president of McCue Mortgage, a direct lender in New Britain, Conn. She suggests that borrowers look at their own financial situations, including how long they expect to live in their homes, before deciding on a shorter refinancing.

Shorter loan terms often mean higher monthly payments. But this may be offset in part by the capturing of very low rates. In the first quarter, borrowers with 30-year mortgages lowered their rates by a median 1.5 percentage points, or a savings of about 27 percent of their rate, the largest reduction recorded in Freddie Mac’s 27 years of analyses.
A shorter term may have some tax advantages as well. You restart the mortgage amortization and pay more in interest initially, Mr. McHugh said; this results in a good tax deduction for a few years.

Shorter loan terms of, say, 10 or 15 years also allow borrowers to build equity much more quickly, even when home prices are not appreciating, Mr. McHugh noted.

Borrowers can achieve similar results by paying down the balance when they refinance, by adding in extra cash — 21 percent of borrowers did so in recent months, Freddie Mac found.

If their finances or jobs are tenuous, some homeowners may be more comfortable refinancing into 30-year mortgages, then making bigger payments as often as they can, Ms. McCue said. If they suffer a financial setback, she said, they will then have the flexibility of falling back to the standard monthly payment.

If you’re not sure which term works best for you, begin your research by picking a good mortgage calculator online and crunching the numbers for various loan terms, Ms. McCue said.

Those who decide not to refinance can still pay off their mortgages faster by sending in an extra month’s payment once a year, said Chanda Gaither, a housing counselor at La Casa de Don Pedro, which works on affordable housing and neighborhood development in Newark. She has seen families save up a small amount of money every month and then annually apply it to the principal. “Or take it out of your tax return” when the refund comes in, she said.

If you made an extra month’s payment each year, your 30-year mortgage could be paid off in about 23 years, Mr. McHugh said.