If you can get a better interest rate on your mortgage, refinancing could save you thousands of dollars over the term of the mortgage and allow you to pay off the mortgage faster. But if you've got a great interest rate, in some cases it may be to your advantage to extend the mortgage as long as possible by refinancing to a 30-year mortgage.
Refinancing to a Longer Term
When refinancing, you typically try to keep the term on the existing mortgage so that you can pay off the mortgage in the same amount of time with lower monthly payments because you now pay a lower rate. For example, if you have 10 years remaining on your current mortgage, you would retain that same 10-year repayment period on your refinance. However, if you want to have even lower monthly payments, you can stretch out the repayment by refinancing back into a 30-year refinance. A 30-year refinance extends the time you take to repay from your current term back to 30 years. For example, if you currently have 15 years left on your mortgage, refinancing to a 30-year loan would allow you to make the repayments over a period twice as long.
Your lender might allow you to refinance for more than you owe if you've paid down your mortgage or your home has gone up in value. If you do a cash-out refinance, your monthly mortgage payment might go up because of the increased debt, even though you are getting a lower interest rate. If you don't want your monthly payment to go up when you do a cash-out refinance, electing to refinance back into a 30-year loan can help you lower the monthly payments back to what you were paying before you refinanced.
Extra Money to Invest Elsewhere
Depending on your level of investing savvy and confidence in your investing abilities, you may believe that you can earn more money investing than you're paying in interest. For example, if you believe you can earn a 7 percent rate of return on your investments and you can refinance down to a 4 percent interest rate, the 3 percent spread represents profit for you if you use the money you aren't using to pay the mortgage for investments. In addition, your mortgage interest (on up to $1 million of debt) and home equity interest (on up to $100,000 of debt) is tax-deductible, so Uncle Sam may end up giving you a tax break on the interest you pay on your mortgage.
Downsides to a Longer Term
The downside to extending the term of your refinance is that you'll be paying interest on the mortgage for a longer time. For example, assume you originally took out a 30-year mortgage and you've been paying it down for 10 years. If you refinance back into a 30-year mortgage, you'll have to keep paying the mortgage for 30 more years, unless you pay it off early. This means it will have taken a total of 40 years to pay off your mortgage -- with the bank charging interest the entire time. Even though your monthly payment will be smaller, more of your payments will go towards paying interest to the bank during the early years of your new loan. However, if you can get a low enough interest rate, the lower monthly payment may allow you to put more money in an investment that yields a higher rate of return.
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