CONGRATULATIONS you’ve bought your dream home. Pretty soon you’ll settle into the routine of making a monthly payment…now it’s time to start thinking about ways to reduce that payment. Here are three strategies you can use to accomplish that goal.
To give a little context and offer actual numbers let’s assume you have a $400,000, 30 year fixed rate mortgage at 6% interest. With these figures, depending on your actual loan terms and variables, you’ll be paying somewhere around $2,000 to $2,400 a month.
Tip 1: Make 1 extra payment every year.
This strategy takes advantage of the “time value” of money; The fact that if you are paying your mortgage over 30 years small monthly increments can really add up.
Making one extra payment per year can have an enormous impact on the final cost of your loan. The extra payment is automatically applied to the principal not the interest. Your balance drops and again, so does the amount of actual interest you will have to pay. You could save as much as $80,000 and shave five years off the life of your loan.
When making extra payments on your loan check with your lender and make sure that it’s possible to do so. It’s also a good idea to confirm that the extra payment will go to the principle. You may need to mark the extra payment specifically to be sure that it does.
If you are not able to do this a great way to accomplish the same result is to make bi-weekly, instead of monthly payments. You are reducing the principal and with it the interest you need to pay back. It is a very small amount but, again it adds up over the thirty years.
Obviously if you are not planning to stay in your house that long you may want to think carefully about this approach. It does take money out of your pocket now and sinks it into the house for later. But even if you plan to flip the house quickly reducing principal and interest will save you money.
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Tip 2: PMI management
If your down payment was less than 20% you would have been obliged to pay private mortgage insurance (PMI).
Few people know that when their mortgage balance falls below 80% of the homes appraised value you can petition your lender to cancel the insurance. This can often happen if your home’s value goes up. It is also the case if you have repaid enough of your principal to move below this threshold. Depending on the terms of your loan and PMI you could save over $200 per month with this tactic.
What you should know about about Private Mortgage Insurance
Most home buyers will make a down payment of 20%, in fact some lenders require that. Primary Mortgage Insurance kicks in if the borrower is unable to make a 20% deposit. The lender looks at the loan as a riskier proposition and PMI is their way of taking out some insurance to cover that extra risk.
- PMI is usually paid by the borrower as part of their monthly mortgage payment.
- The magic number here is 22%; so long as the borrower is current on their payment PMI can be removed when equity in the home reaches 22% (or, viewed another way, when the balance due reaches 78%).
- PMI payments are usually somewhere between 0.5% and 1% of the entire loan so it is essential that the borrow keep a close eye on the state of their equity; you want to remove that extra burden as quickly as possible.
- For every $200,000 of loan PMI is approximately $170 per month.
Tip 3: Refinance
Your financial picture changes over time. It will change for the better if you are making regular payments on your mortgage. One of the most common ways to save money is to refinance your mortgage at a lower rate. Rates fluctuate almost monthly and if you are keeping a careful eye on them you can cash in. However take into consideration that while you will save money by refinancing at a lower rate you will incur other costs. In our example if you can reduce your interest from 6% to 5% it would save you over $200 per month and if your refinance costs are $5,000 you will recoup that money in about 24 months. After that the real savings begin. How to calculate closing costs.
This approach can save you money if interest rates drop significantly. If the change is less than 1 or 2% it may not be worth the effort.
In conclusion
It’s tempting to “set it and forget it”–simply make payments every month and forget about them. With a little intelligence and forethought you can not only reduce the total cost of your loan but also complete the payments earlier than you might think.
