30-Year vs. 23-Year Mortgage: Breaking Down the Differences
When considering a mortgage refinance, homeowners often face the dilemma of choosing between monthly savings and improving monthly cash flow. This decision can be pivotal in shaping your financial future. One strategy to consider is refinancing to a shorter-term mortgage without resetting the clock entirely.
Pro Tip: If your primary objective is to save money over the life of your loan and monthly cash flow isn’t your main concern, consider reducing the term of your mortgage so that your new payment is comparable to your existing payment.
Monthly Savings vs. Monthly Cash Flow
Understanding the distinction between monthly savings and monthly cash flow is crucial for making informed refinancing decisions.
Monthly Savings: Monthly savings refer to the total amount of money you save over the entire term of your mortgage. By choosing a shorter-term mortgage, you can save a significant amount in interest payments. While your monthly payment may remain the same, the total amount paid over the life of the loan decreases because you are paying off the mortgage faster and accumulating less interest.
Monthly Cash Flow: Monthly cash flow, on the other hand, focuses on the amount of money you have available each month after paying your mortgage.
Improving your monthly cash flow typically involves lowering your monthly mortgage payment. This can be achieved by refinancing to a longer-term mortgage or securing a lower interest rate. Enhanced cash flow can provide more financial flexibility for other expenses, investments, or savings.
Mortgage Insurance: What Is It and Why Does It Matter?
When you’re buying a home with less than 20% down, you’re likely going to encounter mortgage insurance—sometimes known as private mortgage insurance (PMI). While it may not be the first thing you think about when calculating your monthly savings or cash flow, it’s an important factor that can influence both.
Why Mortgage Insurance Exists:
Simply put, mortgage insurance is there to protect the lender, not you. When your down payment is below that 20% mark, you’re seen as a slightly higher risk. Mortgage insurance helps the lender feel more confident in lending you the money, but it comes at a cost—a cost that gets added to your monthly payment.
How Mortgage Insurance Impacts Your Monthly Payment:
Think of it this way: without mortgage insurance, your monthly mortgage payment might seem lower, but the upfront cash you’d need to save for a 20% down payment could delay your home-buying goals by years. By opting to pay mortgage insurance, you can buy a home with as little as 3-5% down, keeping more cash in your pocket upfront and increasing your overall monthly cash flow. Yes, you’ll have to factor in that additional monthly cost for the insurance, but you’re also building equity in a home sooner and potentially benefiting from rising home values in the long run.
Dropping Mortgage Insurance Over Time:
The good news? Mortgage insurance isn’t forever. Once you hit that magic 20% equity mark through a combination of payments and rising home value, you can look into removing mortgage insurance altogether. That’s where your monthly savings will really shine—suddenly, you’re pocketing more cash each month without having to worry about that extra cost.
So, when you’re weighing your monthly savings versus monthly cash flow, don’t forget to factor in mortgage insurance. It can be the key to getting into your home sooner while also leaving the door open for future savings down the road.
Case Study: Joe Homeowner
Let’s take a look at Joe Homeowner’s situation. Joe currently has a 30-year mortgage with a principal and interest (P&I) payment of around $2,500 per month. He has been paying his mortgage for four years, which means he has 26 years left on his loan.
Joe is considering a rate and term refinance to take advantage of lower interest rates. Instead of opting for a new 30-year mortgage, Joe might want to consider refinancing to a 23-year term.
Here’s why:
- Maintaining Monthly Payments: By choosing a 23-year term, Joe’s new monthly payment remains around $2,500. This keeps his budget intact, ensuring he doesn’t face any increase in his monthly financial obligations.
- Interest Savings: By reducing the term of his mortgage from 26 years to 23 years, Joe cuts down the overall interest he will pay over the life of the loan. Even with the same monthly payment, he will pay off his mortgage three years earlier, which translates to significant savings in interest.
- Building Equity Faster: With a shorter mortgage term, Joe will build equity in his home more quickly. This can be advantageous if he plans to sell the home in the future or needs to access home equity for other purposes.
Understanding the Numbers
To put this into perspective, let’s look at some hypothetical numbers:
- Original Loan: $400,000 at 4% interest over 30 years.
- Monthly Payment: Approximately $2,500 (excluding taxes and insurance).
After 4 years of payments, Joe’s remaining balance is approximately $370,000. If he refinances to a new 23-year loan at an interest rate of 3.5%, his new monthly payment would still be around $2,500. However, the total interest paid over the remaining life of the loan would be significantly lower than if he continued with the original 30-year term.
Weighing Your Options
When deciding between monthly savings and monthly cash flow, consider your long-term financial goals. If reducing the overall interest paid and paying off your mortgage sooner is more important to you, a shorter-term refinance could be the right move. On the other hand, if you need to free up cash for other expenses or investments, you might prioritize lowering your monthly payment instead.
Final Thoughts
Refinancing your mortgage is a powerful tool that can help you achieve your financial goals, whether that’s saving money over the life of your loan or improving your monthly cash flow. By understanding the benefits of different mortgage terms and carefully weighing your options, you can make an informed decision that aligns with your needs.
For personalized advice and to explore your refinancing options, reach out to Mortgage Mark today. We’re here to help you navigate the complexities of home financing and find the best solution for your situation.
Mark Pfeiffer
Branch Manager
Loan Officer, NMLS # 729612
(972) 829-8639
MortgageMark@MortgageMark.com
Mark Pfeiffer is a Mortgage Loan Originator with CMG Home Loans and a veteran of the mortgage industry since 2003. Mark is responsible for ensuring all loans originated by the Mortgage Mark Team offer competitive terms and close on-time.
We assist clients with all type of mortgage loan programs