This is a guest post from Dominique Brown, a financial planner and personal finance blogger who writes at Your Finances Simplified.
“Buyer’s market” is perhaps the best phrase to describe the housing and mortgage markets today.
If you are buying a home today, you will be able to take advantage of low interest rates and all the blessings a buyer’s market can bestow. However, we are in a stagnant economy and a tenuous job market. If you’re like most of us, you need work to earn those mortgage payments!
In the next few paragraphs, I want to give you some tips and insights that could save you thousands of dollars and cushion your budget against the uncertainties of the economy. The suggestions that follow assume you are average middle-class buyer, purchasing a home for yourself and your family.
Fixed versus Variable Rate
With interests rates at historic lows, I cannot envision a scenario that would justify opting for a variable rate loan. Variable rate loans shift the burden of risk from the lender to the borrower. Risk is why you pay the lender interest. Why should you pay the lender interest and accept the risk of rising money costs? Answer…you shouldn’t! Opt for the fixed rate loan.
DO NOT drain your savings account to make the down payment. Owning a home requires that you have reserves to take care of the inevitable repairs and sundry emergencies that are inherent in home ownership. If you use all your savings for the down payment, you may be forced to borrow to meet these expenses. This will negatively impact your budget and create unnecessary financial hardship. Make the smallest down payment your lender permits. You can invest any surplus to offset increased interest expense on the larger mortgage. I’ll show you how to mitigate those interest expenses later … read on!
Although optimism is an admirable personality trait, shelve it when you are considering the terms of your mortgage. You need to structure your mortgage around a “worst case” scenario. Play the “what if” game. What if I lose my job? What if I am injured at work? What if I lose my overtime? What if my union has an extended strike? What if my spouse loses his/her job? What if I am forced to take a demotion? Worry now…not later. My point is, take the longer term, yes 30 years, even though your present financial circumstances may permit a shorter term and larger monthly payment. I’ll explain later how you can beat the interest expense that is the natural consequence of a longer term.
Read your Documents
Make certain your loan is a simple interest loan; 99% of all mortgage loans are, but be certain! Make sure you understand how your interest is calculated, what the late fees are and when they are triggered. Are there any other penalty clauses, and if so, what are they? One important penalty clause to avoid is the prepayment penalty clause. This allows the lender to, in effect, recover interest that has not been earned. DO NOT sign a mortgage agreement that contains a prepayment penalty clause! Establish a convenient due date but minimize the number of days to the first payment. This will reduce your initial interest expense.
Beating the Interest Trap
Now you can utilize your amortization schedule to reduce interest expense AND reduce the term of the loan. Here’s how! The amortization schedule breaks each monthly payment into its component parts, principal and interest.
We’ll use the sample amortization below to explain how to reduce your interest expense. This is a $100,000 loan at 3.75% with a 360 month term.
When your first payment of $463.12 is due, you can opt to pay the principal for payment # 2 (highlighted in red) in advance. Pay $436.12+$151.09 for a total of $587.21. You can do this, because there is no prepayment penalty in your mortgage agreement. The extra principal payment of $151.09 saves you $312.03 in interest and reduce the term of your loan by one month! Do this as often as you are financially able. You will save thousands in interest expense. You will also reduce that 30 year mortgage term by several years. Even if you are not financially comfortable with prepaying a full month’s principal, pay as much over and above the regularly scheduled payment as possible. You will still save interest costs and retire you loan early.
The result of following these simple suggestions is you can live in your home, not for your home. You have not locked yourself into a high mortgage payment. You are in control. If you can pay more, do it. Make sense? Let us know your thoughts!
About The Author
Dominique Brown is a financial planner, landord, personal finance blogger and video blogger. He is the owner of YourFinancesSimplified.com where he talks about everything from being a new father to his worst financial mistakes. He is also the owner of InsiderRealEstateTips.com where he talks about real estate exclusively. You can find him on Twitter, Facebook, Youtube or Instagram.