There are many terms to describe the process of refinancing your home. Cumbersome and stressful are two that come to mind. But there's another type of term that you should focus on -- the one that determines when you'll finally be debt-free.

When refinancing your mortgage, don't ignore your new loan's term. Homeowners harp on interest rates, points, and loan amounts, and forget to consider whether the standard 30-year term is really their best choice. Most of the time, it's not. Assuming that you don't refinance annually, you've already paid at least a year or two of interest on your current mortgage. Why, then, start over? Refinancing an existing mortgage with another 30-year loan resets your payoff clock and increases the total amount of interest you'll ultimately pay.

Terms and total interest

The standard options for a mortgage refinance are 15 or 30 years. Some lenders also do 20-year amortizations, so ask for rate and payment quotes on all these options. Generally, the rate for a 15-year loan will be between .25 and .50 percent lower than that on a comparable 30-year mortgage. Even if the rate is the same, you'll still save money with a shorter term because there's less time for interest charges to rack up.

Say, for example, that you're refinancing a $300,000 loan. With a 5 percent interest rate and a 30-year term, you'll pay total interest of about $279,770. A 15-year loan at the same rate slashes that number by more than $150,000. Even a 20-year mortgage looks better, with total interest of $175,167. That saves you more than $100,000 versus the 30-year option.

Shortest affordable term

Calculating the shortest term you can afford begins with knowing your monthly payment budget. Using our example above, the 15-year mortgage payment would be about $2,372. The 30-year payment would be $1,610. It's likely that your payment budget will fall somewhere between them. In that case, use a mortgage payment calculator to determine the shortest term you can afford. Continuing with the same example, if we assume a monthly payment budget of $1,850, the right term would be 23 years. Note how increasing the payment by $240 shaves a full seven years off the term.

Armed with this information, ask your lender for a 23-year loan. They may or may not comply. The next best strategy is to get the 30-year loan, and then send in the additional $240 ($1,850 - $1,610) as a voluntary prepayment of principal. If you go this route, verify with your lender how the additional principal payments will be applied to your balance. Then, commit to the higher amount by setting up automatic payments through your online banking system.

At the end of the day, the term of your refinanced mortgage is as important as the rate. Even if you plan on selling the home before it's paid off, the shorter term will enable you to build equity faster. When you focus on this bigger picture, your mortgage refinance doesn't have to be cumbersome or stressful. Instead, it's a process that builds wealth and improves your finances.

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Published on October 13, 2010