The usual reasons to refinance are to reduce the monthly payment or to raise cash. The third option, which is under-appreciated, is to shorten the period of indebtedness.

The usual reasons to refinance are to reduce the monthly payment or to raise cash. The third option, which is under-appreciated, is to shorten the period of indebtedness.

The third option is seldom used.  Indeed, borrowers who refinance into a new mortgage that has the same term as the original term of the existing mortgage – a new 30-year supplanting an old 30-year, for example -- extend the life of their mortgage instead of shortening it. That is not the way to go for anyone who expects to retire someday.

A major reason that few borrowers refinance in order to shorten their period of indebtedness is that the benefits are delayed and seldom displayed. Where the first two options provide immediate feedback in lower payments or cash-in-hand, benefits of the third option are deferred for years. Indeed, unless the decline in mortgage rates has been unusually large, the immediate impact will be a higher monthly payment and/or upfront refinance costs to be paid. The long-run benefits are nowhere calculated.

There are two. The major benefit, in addition to the psychic satisfaction of being out of debt, is enlarged future borrowing power if it is needed. As an example, if they need additional funds when they hit 62 and look to a HECM reverse mortgage to get it, every dollar of debt remaining on their existing mortgage reduces the amount they will be able to draw on the reverse mortgage dollar for dollar.

The second benefit, which arises from the decline in market interest rates, is the reduction in cost. The cost of a new refinanced mortgage carrying a shorter term will be lower than the costs of retaining the current mortgage. Here is an example.

Prudence took a 30-year fixed-rate mortgage of $320,000 at 4.5 % just 5 years ago. That gives her 25 years to go which she would like to cut to 20 years, or even 15 years if that is possible.

On June 7, she could have refinanced into a 20-year mortgage at 3.125% with $5,700 of upfront costs. Her new payment at $1,636 would be just slightly higher than the existing payment of $1,621. But her total costs over the next 20 years would be $398,000 compared to $486,000 if she retains her current mortgage. In addition to being out of debt 5 years sooner, she will save $88,000 during the 20-year period.