Should You Say No to Lengthy Loans?

The costs and benefits of paying down a loan quickly

07/08/2014

Time is money when it comes to loans. In fact, paying down your loan over a long period may end up costing you more overall. The primary benefit of avoiding a lengthy loan, such as a 30-year mortgage, is the ability to save on interest. Unfortunately, that savings comes with the trade-off of larger monthly payments. There are several ways that people shorten the loan repayment period, including choosing a shorter loan term—like a 15-year mortgage—initially, refinancing or paying the loan off early.
 
Forbes contributor Richard Barrington recommends calculating exactly how much you would save in order to make the decision when applying for a new loan.
 
“When you run a 15-year and a 30-year loan through an amortization calculator and look at the total interest payable over the life of the loan in each case, you may find that the savings resulting from a shorter loan gives you plenty of incentive to accept higher monthly payments,” says Barrington.
 
The case is even more attractive for people who are looking to refinance a 30-year mortgage.
 
“Assuming that you’ve paid down some principal on your existing mortgage, it should be less of a leap to refinance with a 15-year loan,” says Barrington.
 
Although a 15-year mortgage can save you thousands in interest compared to a 30-year loan, it is critical to look beyond the attractive prospect of saving money and seriously consider whether larger monthly payments make sense with your current financial situation. It is also important to consider whether payments that seem manageable now are likely to become more difficult in the near future.
 
Consider the stability of your income and of your expenses. If you plan on making any large purchases soon or if your expenses may change dramatically, such as with the birth of a child, you may want to hold off on refinancing.
 
Broker and CEO Emily Ryslinge suggests that people worried about tying themselves to the high monthly payments that come with a 15-year mortgage stay safe by choosing a 30-year mortgage and then pay more each month, as they are able.
 
“You can even ask your loan officer to calculate how much extra to send in each month to pay off your 30 year loan in 15 years,” says Ryslinge. “This will also save you a tremendous amount of money in interest. Even sending in the equivalent of one extra payment a year (take your monthly payment, divide by 12, and add that amount each month to your payment) will reduce the repayment term of a 30 year loan by seven years.”
 
Not only can you save thousands of dollars in interest by paying off your loan early, you can also save by receiving favorable financing on other loans.
 
“Lenders want to be sure you have enough income to pay off loans, and that existing loans don’t eat up too much (usually some percentage) of your income. When you pay off loans, you improve your debt-to-income ratios and are more likely to get a new loan,” says Certified Financial Planner Justin Pritchard, contributor to the banking and loan portion of About.com.
 
One last thing to consider is that paying more toward your loans each month means that you will have less to invest. If you pour all your money into rapidly repaying your mortgage but do not grow your savings by investing, you may not end up in the best financial situation. It is important to talk to your financial advisor to discuss your investment strategy to determine a good balance between investing and paying down loans.
 
If you would like to discuss your mortgage, investing or learning about other ways you can save money, please give us a call.

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