Looking to Save Money on Your Mortgage?
It’s shocking how little many buyers actually know about mortgages despite the fact that the concept is such a common one that most of us will deal with (or currently are dealing with) at some point in our lives.
Whether you’re a buyer looking to purchase your new home or a current homeowner thinking about refinancing, there are a lot of facets to be aware of when it comes to your mortgage. One thing all of these groups share in common is an interest in getting the best possible terms for their loan, so here are the most common ways anyone can save thousands on their mortgage:
Avoid interest-only loans.
In an interest-only mortgage, the borrower only pays the interest on the mortgage through monthly payments for a fixed term, which is usually between 5 and 7 years. After the term is over, they begin paying off the principal of the loan. Unsurprisingly, this usually results in a significant increase in their monthly payment.
Most borrowers either save and pay a lump sum after that term is over or refinance their homes. That’s a risky maneuver, for obvious reasons. An unexpected financial emergency may hinder their ability to save for a lump sum payment, or market conditions may not be favorable for a refinance. In either case, the borrower is on the hook for an amount they may not be able to easily pay.
This is why it’s better to make a larger down payment and stick with more conventional loan terms and start paying down the principal balance of the loan as soon as possible. If you’re planning on moving within a few years, then an interest-only mortgage may be suitable. For most buyers who are invested in their home for the long haul, though, it’s not the way to go.
Avoid ARMs.
ARMs, or adjustable-rate mortgages, are mortgage loans with the interest rate on the note periodically adjusted based on an index that reflects the cost to the lender of borrowing on the credit markets. The loan may be offered at the lender’s standard variable rate/base rate.
ARMs may be viable for, again, borrowers who are only temporarily invested in their property, such as frequent movers.
Still, ARMs aren’t awful. Since their interest rates are adjusted according to the market, they may be advantageous in rates are trending down. Here’s the thing, though: interest rates are definitely not trending down. Interest rates have been at historic lows for the last several years as the Federal Reserve cushioned the economy in the wake of the recession. Even if the Fed weren’t currently increasing its benchmark interest rate (which it is), there would be nowhere to go but up anyway.
This means that ARMs aren’t necessarily the best choice in light of current circumstances if you’re planning to stay in your home for more than a few years, and since rates have little room to go anywhere but up, an ARM may not be a good option even if you’re planning to move in a few years.
Pay attention to your debt-to-income ratio.
Your debt-to-income ratio, or DTI, is a huge consideration for both you as a borrower and your lender. The less debt you have, the smaller the ratio is between it and your income, which means you’ll have more disposable income to either make your mortgage payments or save for unforeseen circumstances.
If you’re currently carrying a lot of debt, you might want to hold off on purchasing your first home until you pay at least some of it down. This is before you even apply for a loan; lenders pay close attention to your DTI. A high ratio may affect their perception of your creditworthiness.
This means they’re likely to assess you as a higher risk borrower, and assign less favorable terms to your loan, which can cost you thousands in the long run. It’s not as cut-and-dry as a single ratio, either. Lenders assess your front-end and back-end DTI, so you’ll want to know exactly where you stand with both. If you have or are applying for a mortgage, the front-end DTI ratio is usually calculated as housing expenses (such as mortgage payments, mortgage insurance, etc.) divided by gross income. In contrast, a back-end DTI calculates the percentage of gross income going towards other types of debt like credit card or car loans.
If you’re going to pay extra to pay down the principal balance, do so in separate payments each month.
If you’re considering paying extra on your mortgage each month towards your principal loan balance, that’s a great thing! You can save yourself a great deal of money over the course of the loan.
Let’s say, for example, that you have a 30-year loan on a $200,000 principal and a 4.0% interest rate. Paying an extra $100 each month towards the principal balance can shave off nearly five years and around $26,000 interest payments. This is because as you shorten the term of the loan, the amount of interest you owe on it decreases accordingly. You can find out how this can work for you with one of the many online mortgage calculators available online. This is something we strongly encourage most homeowners to do if they can.
The kicker, though, is that you need to make these extra payments separately because initial mortgage payments usually go towards the interest on your loan in the first few years, depending on the exact type of loan you have. In other words, don’t just tack on an extra hundred bucks to each check; write a separate check for your extra payments, and don’t forget to write, “for principal only” on it!
If you’re refinancing, keep an eye on rates and the terms of your new loan.
Mortgage refinancing pays off one loan with the proceeds from the new loan, using the same property as collateral. This type of loan allows you to take advantage of lower interest rates or shorten the term of your mortgage to build equity faster.
But it’s important to be analytical and mathematically minded about it, because lenders will push refinancing onto borrowers with exciting sales pitches. For one, remember that discount points, despite the fact that they include the word “discount,” help the lender, not the borrower. There are fees paid directly to the lender at closing in exchange for a reduced interest rate. This is also called “buying down the rate,” which can lower your monthly mortgage payments.
It’s important to keep these closing costs in mind, because they’re added to the principal balance of your loan (which can extend its term and ultimately increase your interest owed). If you’re only saving a few tenths of a percent but face added closing costs to the balance of your loan, then refinancing may not be the best option. It all depends on the math, so be prepared to figure out what works for you.
Also, always request an amortization schedule for any refinanced loan. This will help you make the required calculations.
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- Get It Right Solutions