Do you wish that you had gotten a shorter-term mortgage? Maybe your financial situation is a little steadier now and you think you can afford the higher payment of a lower term. Does it make sense to refinance to get that lower term?
Before you decide, answer the following questions as they pertain to your situation.
Do You Have a Stable Job?
If you refinance into a shorter-term loan, you are going to have higher payments. While those higher payments will pay off your principal balance faster, you have to make the payments or you risk losing your home. What happens if your job isn’t steady and your next job doesn’t pay you as much? Do you want to put yourself in that type of situation?
Do You Have an Emergency Fund?
If you have extra money every month that you are willing to put towards your mortgage, you should probably think about your emergency fund first. Do you have one? Does it cover approximately 6 to 9 months of your monthly bills?
If you don’t have an emergency fund, you’ll need to save one before you refinance. An emergency fund can be used to make mortgage payments if your income stops for any reason. It can also be used for things like replacing the roof, paying for medical expenses, or car repairs. If you use all of your extra money to pay the mortgage, you may not have any liquid funds when you need them.
Have you Saved for Retirement?
Even though it can be exciting to pay your mortgage balance down, it won’t help you during retirement, as your money will be tied up in the home. Do you contribute to your 401K? Do you have an IRA? These are things you should have set up and well-funded before you decide to invest in a shorter-term mortgage.
AT the very least, you should put as much money into your 401K as your employer will match. Otherwise, it’s like giving up free money. Let’s say your employer matches your contributions dollar for dollar up to $5,000. That’s like throwing $5,000 per year out the window! Don’t do it. Invest in yourself first and then consider shortening your loan’s term.
Do You Have Other Debts?
While your mortgage is likely your largest debt, if it’s not your only debt, you should focus on the other debts before you shorten your loan’s term. Unlike mortgage debt, the interest you pay on credit cards and personal loans isn’t tax deductible. It’s probably a much higher percentage than you pay on your mortgage as well.
It’s best if you dig your way out of debt that you have and then refinance your mortgage into a shorter term, if it still makes sense to do so. If you waste the money on the interest on your credit cards and personal loans, you won’t have any disposable income, making it hard to manage the daily cost of living.
How Long Will You be in the Home?
Finally, you need to ask yourself how long you plan to stay in the home. If it’s not very long, you may not want to spend the money on refinancing. Remember, you have to spend money on closing costs in order to refinance. If you won’t stay in the home long enough to realize the benefits of refinancing, it may not make sense to do so.
Alternatives to Refinancing
Did you know that you don’t even have to refinance in order to pay your loan off in a shorter amount of time? You can make extra payments towards your loan’s principal without needing to refinance. Whether you pay a little bit extra every month or you make one-time payments each year, you can pay your principal down as you see fit as long as you don’t have a prepayment penalty.
Oftentimes, this is the best option because you aren’t stuck with a high minimum payment that you may not always be able to afford. If you keep your 30-year term, you can enjoy the lower minimum payment requirements while making extra payments as you are able to do so. Some people apply their tax refunds to their mortgage balance while others just pick a set amount to pay extra each month.
Take your time when deciding if you should refinance into a shorter-term loan. If you find that it’s worthwhile, then make sure you shop around to find the best deal. You may also want to ask about various terms, such as the 15 or 20-year term to help you decide which payment is the most affordable for you.