Most homeowners refinance their mortgages to lower the interest rate and reduce their payments or to convert a portion of their equity to cash. Some do so to trade the uncertainty of adjustable-rate mortgages for the stability of fixed-rate financing.
But a mortgage consultant suggests there's another good reason to refinance: to speed equity buildup.
By refinancing for a shorter term at a lower interest rate, asserts John J. Cunningham, a Denver-based mortgage consultant, a homeowner can build equity faster, save tens of thousands of dollars in interest, and pay off the mortgage sooner.
Although his main business is helping consumers analyze mortgages, Mr. Cunningham said, he also tailors loan payment acceleration programs for them. To illustrate the advantages of building equity by shortening the term of a mortgage, he offers this example, based on a $100,000 30-year loan refinanced from 11 percent to 9.5 percent:
"If the homebuyer pays $2,000 in loan costs and makes the regularly scheduled payments on the new loan, and no more, it takes 18 months to reach the break-even point, where the loan costs are recouped," he explains. "The old payment on the 11 percent loan was $952. The new one is $841, a difference of $111. Paying $111 less each month for 18 months totals just over $2,000.
"But what if the homeowner shortens the term of the mortgage instead of lowering the payment?," he asks.
"Assume a $100,000 mortgage at 20 years instead of 30 years at the new rate of 9.5 percent. The monthly principal and interest payment drops slightly (by $20) to $932.
"The $2,000 in refinancing costs will still be recovered in 18 months. But now the costs are being recaptured primarily as a result of accumulating equity faster than normal.
"At the end of 18 months," Mr. Cunningham continues, "the 30-year refinance will have saved $2,006 in lower monthly payments and will have reduced the loan by $948, for a total savings of $2,954. After the same 18 months, the 20-year mortgage will have saved only about $360 in lower monthly payments, but will have reduced the loan amount by $2,706, for a total of $3,069.
"The homebuyer whose refinancing costs are higher than $2,000," he concludes, "will actually pay for them faster by accumulating equity on a 20-year loan than by enjoying a lower payment with a 30-year loan."