Should you refinance a 30 year mortgage with a 20 year mortgage with a lower rate?

By Michael Jensen, Mortgage and Finance Guru

Edited by Harry Jensen, Trusted Mortgage Expert with 45+ Years of Experience

Updated October 20, 2020

The simple answer to your question is yes, refinancing a 30 year mortgage with a shorter mortgage with a lower interest rate can save you a significant amount of money.

The benefits of a shorter mortgage include paying a lower mortgage rate, reducing your total interest expense over the life of a loan and paying off your mortgage earlier. Specifically, the mortgage rate for a 20 year loan is typically 0.125% to 0.375% less than the comparable rate for a 30 year mortgage.  In short, a shorter mortgage can save you tens of thousands of dollars as compared to a 30 year loan, depending on your loan amount and other factors.

The only downside of a shorter mortgage is that the monthly payment may be higher -- even though your new interest rate is lower than your old rate -- because you repay the loan over a shorter period of time. If you are on a tight monthly budget, a higher payment may stretch you financially.

One way to limit the increase in your monthly payment when you refinance from a 30 year mortgage to a 20 year mortgage is to keep your loan balance the same.

For example if your originally took out a $200,000 30 year fixed rate mortgage with a 4.000% interest rate, your monthly payment is $955 and at the end of year ten your loan balance is approximately $158,000. If you refinance into a new $158,000 20 year mortgage with a 3.750% interest rate, your monthly payment is $937.

This new payment is lower than it would be if you increase your mortgage amount when you refinance. Keeping your loan balance at its existing level offsets the increase in payment that results from choosing a shorter mortgage.

Use ourMORTGAGE REFINANCE CALCULATORto compare loans with different lengths

You should also consider closing costs when you refinance. If you have limited financial resources you could consider a no cost refinance although you pay a higher mortgage rate with a no cost loan. If you have funds available to pay standard closing costs then this approach typically saves you money in the long run because your mortgage rate and monthly payment are lower.

For example, if you reduce your monthly payment by $50 because you pay a lower rate, you save $12,000 over the course of a 20 year mortgage ($50 per month x 12 months x 20 years = $12,000 in total savings). In this case as long as your closing costs are less than $12,000, then it makes financial sense to pay the fees so that you benefit from a lower monthly payment.

The final point to consider is how long you intend to stay in your property and have the mortgage outstanding. If you plan to own your home for a relatively long period of time then refinancing into a shorter mortgage and paying reasonable closing costs usually makes financial sense.

If you plan to sell your home and payoff your mortgage within a shorter time frame, such as less than three years, then choosing a no cost refinance may be the better option because you have less time to recover the closing costs. It still usually makes sense to refinance into a shorter mortgage, if possible, because you build equity in your home faster so you receive more proceeds when you sell your home.

The table below shows refinance rates and closing costs for leading lenders near you. We recommend that you shop multiple lenders to find the best refinance terms.

Sources

"Adjusting the length of your mortgage."  A Consumer's Guide to Mortgage Refinancings.  The Federal Reserve Board, August 27 2008.  Web.