Mortgages. Even the name sounds like someone attaching chains to your legs, doesn’t it?
But there’s good news: mortgages don’t have to be ominous, and if you do them wisely, you can come out ahead on your mortgage decision.
Let’s start with what a typical mortgage looks like and then we’ll talk about some strategies to save money.
Mortgage Basics
Term
The most common mortgages are either 15 or 30 years long. While there are other terms, because so many banks compete in the 15 and 30 year arenas, you’re much more likely to find competitive rates. Generally speaking, if someone offers you a mortgage that isn’t a 15 or 30 year note…..run.
Rates
There are (generally) two types of mortgages: fixed and adjustable rate loans. Fixed rate loans guarantee that you’ll have the same rate for the entire term of the loan. These are attractive when rates are low. When rates are high, some people opt for adjustable rate loans. These loans will move as interest rates rise and fall.
If you purchase an adjustable rate loan, you’ll want to ask your lender a few questions:
How often will the loan adjust?
What are the maximum amounts a note can rise or fall? (many loans cap the amount they can change in a year)
One offshoot of an adjustable rate loan is a balloon loan. These loans generally keep a fixed rate for a short period, at the end of which you’re forced to refinance. An example of a balloon loan is a 7 year balloon. That means you have a fixed rate for seven years but then the loan ends.
Here are questions to ask about your balloon loan:
Is the rate fixed or adjustable before the balloon is due?
What’s the penalty if I don’t secure other financing at the end of the balloon? (You want to be clear about the fact that you’ll probably lose the house.)
How long is the period until the balloon payment?
Other Fees
Mortgages can be riddled with additional fees. Here are few to watch out for:
Appraisal fee – In the area where I live appraisals cost around $350. However, I’ve been told these vary widely around the country.
Title search – Your mortgage company has to make sure there aren’t any liens filed against the title. These costs vary widely.
Application fee – This covers the cost of processing your application and checking your credit.
Origination fee – If you work with a broker, this represents their commission.
Mortgage Underwriting fee – Here’s the “garbage can” of fees that are added to a mortgage.
How to Lower Your Interest Rate
Pay Points – To keep it simple, points are upfront fees you pay to lower the interest rate on the loan. Ask your lender how much points will cost for your mortgage and how that’ll lower your interest rate and payment.
How to Lower Your Closing Costs
There are two options and people often get them confused:
Costs rolled into the loan – I’ve met tons of people who think they’re getting a loan without closing costs. That isn’t true. They’re actually getting a loan where the mortgage team has raised the cost of the loan by letting you borrow that money as well.
No closing cost mortgage – Often this is my favorite type of loan. You’ll pay zero fees for the loan but your interest rate will be a little higher (the company needs to make money somehow….you just decide how you want them to take their fee). I prefer not to pay costs even though this can be moe expensive over the life of the loan because it makes my decision-making easier in the future. I don’t have to worry about how much money I’ve sunk into the existing loan.
Note: Sometimes people think they’re getting taken advantage of by their mortgage company because they were sold a “no closing cost” loan but ended up with a higher loan amount. If that’s your situation, you might not be getting taken advantage of. Here’s the thing: because you skip a month’s worth of payments when you refinance, your loan amount actually goes up by the amount you didn’t pay. In effect, you’re rolling in the month you didn’t pay….but not closing costs.
Mortgage Strategies
Two strategies:
1) Take a longer term loan and save the difference elsewhere. I’m a big fan of keeping my money flexible, but I also want to pay my loan early. I detest 15 year loans unless there’s a huge difference in the rate between the 15 and the 30. With a 30 I can pay my loan along the 15 year timeline but back down the payment schedule if I have a financial meltdown, such as if I lose my job or get disabled. Some people like to save the extra money into the loan. I prefer saving it into an S&P 500 mutual fund.
2) Make extra payments during the year by changing your payment schedule. Here’s a plan: make an additional payment two weeks early and then continually pay more every two weeks. If your bank will put those payments on your loan as they come in, this will reduce interest by a ton. If not, you might be wasting your time. Check with your bank to see how they’ll handle you paying early (you may just have to make one extra payment a year).
Mortgages don’t have to be an ugly beast. You can understand mortgages enough that they can help you secure a better loan on your residence or help you begin to build a real estate empire!
When he’s not finding ways to annoy his banker by lowering his debt, you’ll find Joe co-hosting the laid back financial podcast Stacking Benjamins.
Photo: American Advisors Group
