When they refinance their mortgages these days to cash in on lower interest rates, many homeowners are actually increasing the size of the monthly payment they must make.
Their purpose is to save money - not now, but later - by shortening the terms of their mortgages, typically by switching to a 15-year instead of a 30-year loan.A shorter mortgage costs more now, but can save many times that extra outlay in reduced interest expenses over the life of the loan. It also allows for faster buildup of the owner's equity in the property.
On top of that, lenders typically sweeten the pot by offering a lower interest rate on a 15-year fixed loan than they charge for a conventional 30-year deal.
To see how this all adds up, consider the example of a $150,000 mortgage, available for 15 years at 7.5 percent or for 30 years at 8.125 percent.
Gregory Dorsey, associate editor of the newsletter Personal Finance in Alexandria, Va., calculates that the 15-year borrower would have a monthly payment of $1,369, compared to $1,114 on the 30-year loan.
But by the time the loan is repaid, the shorter-term borrower will have saved more than $150,000 in interest costs. Interest over the life of the 15-year mortgage amounts to $96,473, compared to $251,138 for the 30-year loan.
On the face of it, the 15-year loan enjoys a big edge. And indeed, many experts recommend it enthusiastically for people who can afford the extra drain on their cash flow.
But some advisers, including Dorsey, assert that the advantages are not quite as big as they may appear.
For one thing, Dorsey notes, the savings on interest are reduced by the value of the tax deduction borrowers get on the mortgage interest they pay. At current tax rates, that can account for as much as 33 cents of each dollar.
"Another drawback to the 15-year loan is that it ties up money you could use elsewhere," he adds. "The extra money could be invested in stocks or mutual funds at a potentially higher return rate."
If you're having trouble deciding between the 15-year and 30-year routes, there are several compromises available. For instance, you can consider a 30-year mortgage with payments due every two weeks instead of monthly.
That allows you to pay off the loan a little faster without going to the extreme of the 15-year deal.
"Because you're actually making 26 payments during the year, or a whole extra month's worth of payments," says IDS Financial Services in its book Money Matters, "you pay off your loan sooner and save on interest expense."
Still another option is to go with a 30-year mortgage from a lender that allows you to make voluntary extra payments of principal - a setup that can allow a lot of flexibility along with the benefits of accelerating the loan payoff.
Counsels the advisory publication 100 Highest Yields: "Before sending in an extra penny, resolve these issues first:
"1. Does the lender permit prepayment? Some do not and will charge you a penalty;
"2. Are the extra payments applied directly to the current mortgage balance or to the back end of the loan? If it's the latter, the interest savings will be considerably less;
"3. Can you afford to tie up the money in your house? Once you make the extra payment, the only way to put the money back into your pocket is to borrow against your equity via a credit line or loan."