More homeowners shorten terms when refinancing

House on pile of money

More than a third of homeowners who have refinanced their homes recently have shortened their loan terms, according to data released this month by mortgage giant Freddie Mac.

That's the largest percentage of mortgage refinances converted from 30-year, fixed rate loans to 15- or 20-year loans since 2003.

And even if they don't opt for a shorter-term loan, some 95% of homeowners who refinanced in the second quarter chose a fixed-rate loan over an adjustable-rate mortgage, Freddie Mac's data show.

The Federal Home Loan Mortgage Corp., or Freddie Mac as it's commonly called, is a government-owned mortgage company that buys home loans from banks and other lenders.

Choosing a shorter financing period can be a smart move for some homeowners, as it dramatically reduces the overall cost of a mortgage.

In addition to paying interest for fewer years, shorter terms have lower interest rates.

On a $200,000, 30-year, fixed rate mortgage with a 4.41% interest rate (the average cost according to Interest.com's most recent survey of major lenders.), you would pay $160,973 in interest over the loan’s life.

But on a $200,000, 15-year, fixed-rate mortgage with a 3.63% interest rate (the average 15-year rate in our survey), you would pay $59,662 in interest over the loan’s life.

The difference? The 15-year loan saves $101,311.

That amount of money can make a significant difference in your long-term net worth, especially if you invest the savings.

Refinancing into a shorter term seems like the obvious choice from a long-term perspective. In the short term, however, many borrowers can’t afford it.

The downside of choosing a shorter term is that it increases the monthly payment.

Even for borrowers who can make the higher payments, choosing a higher monthly payment might seem too risky given concerns about unemployment or about economic performance in general.

The monthly payment on $200,000 borrowed at 4.41% for 30 years is $1,002, while the monthly payment on $200,000 borrowed at 3.63% for 15 years is $1,442.

The larger the mortgage, the bigger the monthly payment increase when shortening the loan’s term.

Our 15-year vs. 30-year mortgage calculator can help you figure out the potential savings for the deals you find.

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