by Christy Bieber | Oct. 3, 2020
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Raising your monthly payment doesn't always mean your loan is more expensive.
Many homeowners are taking advantage of record-low mortgage rates to refinance their loans. I'm one such homeowner, as I recently secured a new mortgage to pay off my old one.
But while most people opt to refinance in order to lower their monthly payments, I raised mine significantly. In fact, after refinancing, my mortgage payment more than doubled.
That may not seem like a smart financial move at first glance. After all, why take on a new refinance loan that's more expensive? But the reason is simple: My monthly payments went way up, but my total borrowing costs went way down.
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Here's why the monthly payment on my mortgage went up so much:
The interest rate on my refinance loan was lower than both my original mortgage and the debt I paid off. As a result, I reduced my total interest costs substantially.
When I made this move, I was just a few years into my scheduled repayment. That means I've also significantly accelerated my payoff schedule. Paying my loan off years earlier means I'll dramatically reduce the amount of time it will take to pay my creditors. As such, I'll save thousands on interest. That's true even though my new loan balance is higher due to the cash-out refi.
The catch is, I'll have to make much larger monthly payments -- more than double what I was paying before. But it's worth it to get free of my larger mortgage debt much faster.
This approach doesn't make sense for everyone. After all, mortgage rates are near record lows right now. The return on investment from early debt payoff is simply the money you save in interest payments. It doesn't make a lot of mathematical sense to pay off a loan ahead of schedule when it's charging just 2% or 3% interest. At least, not when you could make 7% or 8% average annual returns by, for example, investing in the stock market.
But there are psychological benefits to not having debt, and those are important to my husband and me. We want to own our home free and clear so we have fewer monthly obligations and more flexibility in what we do with our money. And we can afford to accept a lower return on investment on the money we're using to pay off our mortgage early. That's because we also invest a lot for retirement and know we're meeting our goals.
The cash-out refinance made sense because we used it to pay off other secured debt (in our case, another mortgage on a different property). Cash-out refinance loans can be a good move in other situations because they often reduce debt payoff costs. But be careful: You'll take on considerable risk if you convert unsecured debt (such as credit card debt) into secured debt.
Refinancing into a mortgage with a shorter loan term was the right move for me because one of my key financial goals is to have no debt at all.
If that's the case for you, there's never been a better time to take action. The average interest rate on a 30-year loan is at an extremely affordable level, coming in below 3.00% most days. And the average rate on a 15-year loan is even lower, trending below 2.50%.
Just make sure that you really can afford the 15-year payment without compromising other goals. If you aren't confident, you could always opt for a 30-year loan and pay it off ahead of schedule. You'll miss out on the unbelievably low 15-year loan rates, but you won't risk missing a mortgage payment.
Chances are, interest rates won't stay put at multi-decade lows for much longer. That's why taking action today is crucial, whether you're wanting to refinance and cut your mortgage payment or you're ready to pull the trigger on a new home purchase.
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