The best kept secret in the housing industry is just how easy it can be to shave years off your home mortgage loan and save tens of thousands of dollars in the process. Mortgage lenders don't want you to know this, because it takes money out of their pocket, but the fact is that there are simple strategies that home buyers and existing home owners can use to significantly reduce the cost of a home mortgage.
1. Realize that mortgage interest is amortized.
Basically this means that the typical mortgage payment is “front-loaded” to pay interest first. You'll pay on your 30 year loan for roughly 12 years before you actually start to make significant progress paying down your loan principal. Most of your payments for the first 10 years will go to the lender in the form of interest on your loan.
30 year loans are preferred by most buyers because the payments are lower, but the total cost of the home loan is much higher. To get around this, plan ahead to add an additional “principal payment” of $50 to $100 per month. Send this amount on a separate check, with your regular mortgage payment check. If you have a $150,000 mortgage at 4% interest, you're looking at $107,804.26 just for interest!
But if you pre-pay an additional $100 per month from the very first month, you'll save more than $21,000 in interest, and eliminate 64 monthly payments!
2. Mortgage Interest Is Calculated Annually. If your interest rate on your loan is 4% then you'll pay a full 4% each year on your outstanding loan balance. For example, if you borrow $150,000 to buy a home, the first year interest will equal roughly 150,000 X .04 = $6000 in year one. In this example, that $6000 worth of interest is divided by 12 months to determine the amount of interest you'll pay on a monthly basis. You don't pay 4% over the 30 year life of your loan. You actually pay 4% per YEAR, for 30 years! As the balance on the loan goes down, so does the total interest amount due.
This is the essence of amortization. It helps to understand this principal by playing with a mortgage amortization calculator and seeing how this actually plays out over time. A quick online search for “mortgage amortization calculator” will turn up plenty of sites where you can see how this works.
3. Government Insured Loans such as FHA and VA loans, are loaded with fees and other expenses that add significantly to the cost of your home loan. Yes your down payment is lower or even zero, but this will add tens of thousands of dollars to the cost of your loan.
I recently sold a home to a buyer who was using a VA loan to purchase the home with “no money down”. His closing costs amounted to $5170 in loan fees for a $50,000 home! They were financed into the loan, but this will add thousands of additional dollars more, in interest expense, to the cost of this loan. Making it “easier” to get into a home may have good intentions, but this makes it much harder for a borrower to pay down their loan and accumulate equity.
The bottom line is “nothing down” is attractive but buying this way will cost you much more in the long run. Plan ahead when possible to save for a down payment so that you can avoid the fees and interest that get added in with these loans. Saving tax refunds for a down payment is a smart idea if you are renting at present.
As with the first example, if you have to use a “low or no down payment loan” be sure to plan to pay an extra amount each month, over and above your regular monthly payment. This is a great way to reduce your costs and pay down your loan faster. The added expense of using a government insured loan can be reduced if you use a pre-payment strategy.
4. Thinking of refinancing to get a lower interest rate? I was recently contacted by a home owner who was contemplating refinancing their existing mortgage loan balance in order to get a lower interest rate.
The problem is, that this may, in most circumstances, result in thousands of dollars in closing costs for the “refi” loan. This buyer only had about 5 years left on a 15 year loan, but they were wondering if reducing their interest rate by a full percentage point or two might be worth it.
I helped them save the costs of the “refi” by showing them how to get the same effect by simply paying an additional amount on their existing mortgage each month. The additional payments of about $200 per month in this case, eliminated the need to refinance, saving the home owners several thousand in loan costs, and had the same net effect of reducing their interest paid so that they received the benefit of a refi without having to pay for a new loan. It will also reduce their loan payoff time from 5 years down to around 3 years.
Building equity is what home ownership is all about. The safest path to financial security and independence is right through your living room. There is no greater security for the average person than having a home that is paid for. A simple prepayment strategy can help anyone achieve their financial goals faster with much less risk. ***
About the author: Donna S. Robinson is an Atlanta native, 18 year veteran of the real estate industry and residential real estate market expert. She is the author of "Real Estate Investing Fundamentals & Strategies". Follow her on twitter @donnaconsults Watch her videos here. read more articles and contact her about real estate business consulting services on her website.