Term reduction is defined as a Strategy used in a mortgage refinance, where improved cash flow is used to accelerate repayment of the underlying debt. Keep in mind, there are only three things we can do with found money (reduced payments is found money).
- Pay off Debt
- Wave/Invest it
- Spend it
In this example, we will “repay debt” that they already have, their mortgage, resulting in:
- Faster repayment – and an Early Payoff
- Keep the same payment as today
- Significant interest savings
- Increased net worth
This client has total borrowing of $408,000. They are going to be debt-free in 24 years and two months and this graphically shows the debt coming down over time. It shows the interest they are paying overtime, $164,000 and their current minimum monthly payment is $2,735.
With the Term Reduction Strategy, we are going to reduce their mortgage interest rate, capture the expense of the refinance – total borrowing is $415,000 now.
Notice they are debt-free in 17 years, so they have taken seven years off the debt. And then you will see the interest paid is $148,000 so significant interest savings. And of course, they pay off the mortgage early. Their increased net worth is $71,000, which is fantastic. And if for some reason they need to drop down to the new required minimum payment of $2,246 – they will have the use of the cash flow savings of $489 a month, Term reduction can be done in two ways. 1) Add the $489 automatically to the new mortgage payment or 2) design it as a 17-year fixed term with the higher required payment, either result is the same. But you have more control and flexibility with Option #1 as you get to control the cash flow instead of the lender.
Check out more of our Borrow Smart/Repay Smart Lessons on how to make simple changes to increase your Net Worth and move towards Financial Freedom.
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