Advertisements everywhere sell the benefits of refinancing your home loan into a new 30-year fixed rate mortgage. These loans offer significant benefits, including low payments and historically low rates. That being said, going to a shorter loan is an even better idea for many homeowners.

There are typically three factors that go into a loan's cost. The first factor is the amount of closing costs and fees that the lender levies--more fees lead to a higher effective rate. The second factor is the interest rate, which is the bank's annual charge for the use of their money, expressed as a percentage of the loan balance. The final factor is the amortization period, which is the amount of time that it takes to fully pay off the loan. With a 30-year loan, you will spread the principal balance over 30 years, paying interest all of the time.

In exchange for having a higher payment, refinancing your home into shorter than the traditional 30-year amortization mortgage has four benefits.

• Lower interest rates
• Reduced interest expense
• Faster pay-off of the mortgage
• Greater equity build-up during the life of the loan

Lower Rates

Banks charge interest to compensate them for your use of their money. Generally speaking, the more risk that they take in lending, the more they charge. With mortgages, the longer the bank's money sits in your hands, the more risk that they take. As such, shorter-term mortgages are typically discounted. For example, if you qualified for a 30-year refinance at 4.02 percent, you may also qualify for a 3.37 percent 15-year loan.

Reduced Interest Expense

Refinancing your home to a shorter-term mortgage also reduces your total interest cost. Since you use the bank's money for a shorter period of time, you also spend a shorter period of time paying them back. Going from a 30- to a 15-year mortgage should reduce your interest cost by over 50 percent.

Faster Pay-Off of the Mortgage

The most obvious benefit of going to a shorter loan is that you will pay it off faster. A 15-year loan pays off in half the time of a 30-year loan. If you are 35 years old, you could have your mortgage paid off by your 50th birthday instead of your 65th birthday. This difference could make early retirement a possibility.

Greater Equity Build-up During the Life of the Loan

Shorter loans also benefit you throughout their lives. Because the way that they work is to have you pay off more principal every month, you will not only get to your payoff date sooner but also build more equity over time. For example, while the first payment of a 30-year mortgage with a $250,000 balance contains $360 in principal, a 15-year mortgage's first payment pays off $1,015.

Refinancing a Home: An Example

To understand the benefits of refinancing to a short-term loan, let us consider a real world example. In this scenario, a homeowner decides to refinance the balance of a five-year-old mortgage with an initial balance of $250,000 and initial rate of 6.35 percent. Their two choices are a 30-year loan at a rate of 4.21 percent or a 15-year loan at a rate of 3.47 percent:

While a 30 year loan carries $412 a month in payment savings, it also extends the loan by 5 years. The 15 year loan costs only $111 more than the original loan, but saves 10 years and almost $170,000 in interest.

Refinancing your home is serious business. Your decision will have a great impact on your financial future. Understanding exactly all elements involved will help you make the correct decision for your situation.

If you are considering the option of refinancing your home, download our 10 Things To Consider Before Refinancing e-book. It will answer many of your questions and give you the information you need.