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With Mortgage Savvy You Can Reduce Your
Monthly Payments--Or Your Total Cost |
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When you purchased your home you most likely shopped around, looking carefully for the mortgage with the best rates and closing costs you could find. But the search for savings in your housing costs doesn’t have to end when escrow closes; there are many strategies for minimizing your mortgage expenses.
Short Term Goal—Reducing Monthly Payments
If your goal is reducing your monthly payments, you have probably already thought “refinance” but may have wondered if the savings would really make a difference after the costs of taking out a new loan are accounted for. As a general rule, refinancing is probably worth your while if you can reduce your interest rate by 2% to 3% and you do not plan to sell your home for at least 16 to 18 months (the length of time necessary to recoup the costs of the new loan). After that initial period, the interest savings constitute money in your pocket.
If your current mortgage is an adjustable rate loan, you may be able to reduce your monthly payment if you check past adjustments and find an error in the calculations causing you to pay too much. (Of course, there is also the chance that you’ll find an error causing you to pay too little, too.) Internal mortgage industry audits have shown that many Adjustable Rate Mortgages (ARMs) do contain adjustment errors, usually innocent ones caused by the many variables lenders work with in calculating ARM payments.
Understanding the variables used to calculate your payments—such as the index the loan is tied to, the date for loan recalculation, and the way in which the interest rate is to be rounded off—is essential to verifying whether or not your payments are too high. This information is all in your closing paperwork.
Some indicators that your loan may warrant review include complicated formulas or frequent adjustment periods, a recent sale of the loan to another investor, or an origination date before 1986, when guidelines for ARMs were much looser than they are now.
Even if you can’t reduce your actual loan payments, there are other strategies for optimizing your housing budget. You could cancel mortgage life insurance, for example. Intended to pay off your loan if you should die before doing so, these policies are often overpriced and unnecessary. In fact, your heirs may well be better off keeping the mortgage and making the monthly payment. (Financial advisors says conventional term life insurance is almost always a better way to go.)
And you may also be able to cancel private mortgage insurance, which covers your mortgage lender against the risk of your default. See the story, "Changes to Private Mortgage Insurance Policies May Save You Money" for detailed information.
If your loan contract includes a grace period on the due date of your payment, you might garner a little extra interest by delaying mailing your payment by a week or two. But be very careful if employing this tactic: you wouldn’t want to damage your credit rating in any way.
And finally, you should always be sure to take any tax credits you can for the interest you pay on your mortgage, your property taxes, and, if you purchased your home this year, any points you paid in return for a lower interest rate.
Long Term Goal—Reducing Your Overall Loan Cost
If monthly cash flow isn’t your biggest problem, you might want to consider these strategies for prepaying your mortgage loan to shorten the number of years you pay and thereby your total interest.
Of course, in some cases prepaying a mortgage isn’t the best financial move. If yields available from other investments are higher than your loan interest, for example, it might be more prudent to invest your extra cash. And you may find the tax deduction for that mortgage interest too valuable to give up.
On the other hand, for many homeowners, prepaying their mortgage in manageable increments is a wise way to make the most of their money and their investment in their home.
If your mortgage allows prepayment, get a letter from the lender attesting to that fact. It’s a good protection for you if there are any questions later about how you’ve handled your loan.
Once you know there are no prepayment penalties or prohibitions, work out a schedule to pay a little extra into the principal of your loan on a regular basis. One way to do this is to divide your monthly mortgage payment by 12 and add that amount to each monthly payment. The net result of this system will be that you have made the equivalent of 13 payments by the end of the year, adding a whole extra payment without really “scrimping” to do it.
This is the same net effect achieved by the biweekly payment programs some lenders offer. Be aware that you do not need to formally change your payment schedule—or pay the fee some lenders charge to do it—to attain these savings.
Another way to take principal—and years of interest—off your loan is by adding an additional month’s principal to each month’s payment. To do this, you need a payment schedule from your lender that itemizes how much of each current payment goes to interest and how much to principal.
Whichever method you employ, make a note on your check telling the lender that the extra payment is to be applied to principal reduction. This prevents the money from being misapplied to taxes or insurance premiums. Some advisors even recommend sending your prepayment on a separate check (with your loan number clearly identified) to further minimize possible confusion. And do remember that prepayment for principal reduction does not mean that you can skip forthcoming monthly payments; it is important to your credit rating that you continue to make regular, on-time payments until your mortgage is paid in full.
Either one of these strategies can save you thousands of dollars in the long run—and perhaps even make a difference in the not-so-distant future: building up your equity quickly can speed your qualification to cancel the extra charge for PMI.
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