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millennial mortgage shopping

Three reasons millennials don’t shop for mortgages

It never fails.  Millennial buys a home, thinks all is good in the world and only then realizes they just got taken to the cleaners on their mortgage.  They are then stuck in a loan with an unnecessarily high payment every month for years to come. How did they end up in that situation?  Why didn’t they take time to explore mortgage options?  Here are the top three reasons millennials don’t shop for mortgages.

1. “I was scared by my real estate agent”

A millennial may never admit it, but they are subject to human emotions just like the rest of us. When it comes to a big purchase, such as a home, it is human nature to want to avoid risk. Some agents take advantage of this and inject questionable statements like this:

  • “Our in-house lender is always the best.”
  • “Her service is great and she’ll be at closing, nobody else ever does that.”
  • “Those online lenders, stay away!  They’ll never close on time!”
  • “Our in-house lender will shop rates for you, you don’t need to.”

Facts: Discouraging a home buyer from mortgage shopping is 100% unethical – and could even be illegal!  There are many incredible loan originators out there and many attend closings regularly. A single lender or broker can’t shop mortgage rates for you (learn why).

To understand why a real estate agent may steer a borrower to a specific lender, let’s follow the money!

The money trail

A real estate agent makes money when a house is sold or bought via commissions. The rate and loan program obtained by the homebuyer is irrelevant to the real estate agent’s income.  Their primary goal is to get the transaction done.  Until that moment, they haven’t earned a penny.

Additionally, many real estate agents have co-marketing agreements with specific mortgage lenders, brokers or loan originators. If these mortgage professionals don’t see an ROI on their investment of marketing dollars, the real estate agent stands to lose at least part of their marketing presence.  Therefore, the real estate agent wants to “feed” the mortgage professional to continue the financially beneficial co-marketing arrangement. 

With these in mind, is it any wonder that an agent will aggressively push you to a specific lender or mortgage broker?

Not all agents are the same

While many tech disrupters offering flat fees or “no-commissions” on real estate sales solves some of the problems, one major money problem remains.  Despite the removal of commissions, real estate agents may still be receiving funds from a mortgage broker or lender in the form of a co-marketing agreement or “MSA”.  This means they will still push a homebuyer to a specific lender, robbing them of the opportunity to shop for their mortgage.

How can this problem be solved?  You simply need to find an ethical real estate agent who isn’t “hooked” on the money coming from one specific lender.  Before you legally engage with any real estate agent, simply ask this question: “Do you receive money from any specific mortgage broker or lender?”

If the answer is “yes”, walk away and find someone else who will be just as interested in helping you save money on your mortgage as they will in finding you the house of your dreams.

2. “I used an app”

Every lender claims to have the tech to close your loan faster than you can say “mortgage transaction.” Can they really?  And if they can, who is actually the winner of this perceived huge investment in technology?  Do lenders make these massive investments purely for the consumer experience?

No, they sure don’t.

Fact: The shorter your loan is in processing, the lower the likelihood you’ll shop around or be solicited by other lenders and brokers.

Avoiding competition is a good thing for mortgage lenders and brokers, but not consumers.  When a millennial decides to not consider alternatives, voluntarily or involuntarily, the lender or broker wins.  The government has been fighting to help consumers shop for years, instituting more robust disclosure time periods and new documents – but the tech industry has quickly outpaced any government intervention.

Tech helps you shop too

Fortunately, the digitization of mortgages has made mortgage shopping easier provided you can avoid the common pitfalls.

Pitfall 1: Sharing your name, email and phone number with shopping sites who send it to multiple lenders.  This will get you bombarded with calls and you’ll wish you never uttered the words mortgage.

Pitfall 2: Shopping over the course of several days.  Rates change every day, so an apples-to-apples comparison is always essential.

Pitfall 3: Shopping while uninformed.  We tend to consider the use of a mortgage concierge a good thing but hey, we may be biased ūüôā

Solutions to mortgage shopping

So, how can this problem be solved?  Fair warning, the answer may require that you have a conversation with an actual human at some point who isn’t your parent or friend who doesn’t know a lick about mortgages.

Solution 1: Our particular solution is to use MortgageCS’ concierge program which is free and provides education and insights from day 1 of your shopping through your loan closing.

Solution 2: Other options are becoming a mortgage expert by holding numerous conversations with many banks, lenders, and brokers all while resisting the urge to have your credit pulled numerous times and getting bombarded with follow-up calls and emails.  Grow thicker skin and don’t be afraid to say “no” and you’ll be all set here.

3. “I am subject to advertising”

It may be hard to admit, but marketing messages can impact everyone – even tech-enabled millennials.  From TV spots to billboards and creative event sponsoring, mortgage companies are investing more and more each year to maintain scale and keep their operations growing.  After all, they have an investor base or shareholders to keep happy.

Remember this: A mortgage is a single transaction, creating a predetermined amount of income. It follows that a company with lower costs and all else equal could deliver a better mortgage rate and fee structure.  While company size and other factors can sometimes influence this, you should read this first: Do mortgage brokers act in their customers best interest?

Now that you know the three reasons millennials don’t shop for mortgages – you can ensure you don’t fall victim to the same influences!

Share this to help your friends – they can use their savings to take you to a nice dinner one day!

mortgage brokers

Do mortgage brokers act in their customer’s best interest?

By definition, a broker is a person who arranges or negotiates something like a settlement, deal, or plan. It follows that mortgage brokers¬†arrange or negotiate a mortgage.¬† But what does “arranges or negotiates” really mean?

More importantly, does a mortgage broker always act in the best interest of their customer, the mortgage borrower?

These questions come up whenever we meet with financial advisors. Understanding the answer (hint: it is not a simple yes or no) is essential for a fiduciary advisor who wants to remain, well, a fiduciary advisor. Failing to understand this answer results in failing to look out for the best interest of your client. 

Let’s examine how mortgage brokers come up with their mortgage rates.

How mortgage brokers come up with rates

A mortgage broker will compare various wholesale lenders when examining loan options for a potential customer.  Wholesale lenders (which have approved the mortgage broker as a partner) will supply rate sheets or the raw data to populate loan pricing software.

In this sense, wholesale lenders are just like wholesale suppliers in a retail market. They can have specialties such as “jumbo loans” and rate or pricing differences will certainly exist amongst them.

The graph below represents the wholesale price from three different wholesalers available to¬†a mortgage broker. For our purposes, we’ll imagine there are just three different wholesale lenders being considered for a particular loan.¬† Truth is, there could be many more options considered by one mortgage broker.

Mortgage broker wholesale pricing

To grasp the concept of how this process works we are omitting the actual interest rates.¬† Rather, we are going to focus on their relative position to each other. Note the Y-axis is simply “Interest Rate” and void of specific numbers.

In the case above, Wholesale Lender 1 is offering the lowest wholesale rate given the mortgage customer’s credit, income, and other criteria. In contrast, Wholesale Lender 3 is providing the highest wholesale rate.¬† Lower rates are always better when other things such as origination fees and discount points are held constant.

With an understanding of the mortgage broker’s “suppliers,” let’s move on to how the mortgage broker makes money.

A mortgage broker adds margin

A mortgage broker will add a retail margin, or markup, to each wholesale rate.  These two items, when combined, determine the final interest rate presented to the mortgage customer.

Industry compliance and several other factors ensure that a specific mortgage broker earns the same markup on each loan they could offer.  As a result, the same margin is added on top of each wholesale rate.

Mortgagebrokeraddsmargin

With the retail margins added to each wholesale price, the relative attractiveness does not change. Wholesale Lender 1 + broker margin is still the most attractive loan option.  Said another way, this wholesale price and the margin combined will result in the lowest rate for the mortgage customer.

A mortgage broker presents their best option

Mortgage brokers want to present their best option to increase their chances of winning the loan business. They are indifferent as to which option they provide because they generate the same margin in all cases. In this sense, a mortgage broker does “shop” rates in some way.¬†But there is MUCH more to the story.

Mortgagebrokersbestoption

The fact is, there are many wholesale lenders and a mortgage broker selects a certain number with which to partner. While a mortgage broker may have access to many wholesale lenders, they will NEVER have complete representation.

Other mortgage brokers have their own best options

Each mortgage broker has an individual set of wholesale relationships. These relationships can be based on familiarity, proximity, or any other factor.

Additionally, each mortgage broker must be approved by a wholesale lender in order to offer their products and terms. Some wholesale lenders enforce minimum production requirements in order for mortgage brokers to remain “active” with them. Further, certain mortgage brokers can receive better/worse wholesale pricing based on a range of factors including quality of submissions and volume of transactions monthly/quarterly.

As a result of these factors, each mortgage broker will have access to a “best wholesale price.”¬†Said another way, they will each have a different starting point with which to build their retail rate.

Otherbrokerswholesalelenders

Mortgage Broker 1 has presented the wholesale price that is lowest from his stable of options. Mortgage Broker 2 has access to a lower wholesale price. Mortgage Broker 3 has access to a less favorable wholesale price Рthe worst of the bunch.

If we assumed (wrongly, btw) that retail margins are all the same, then we see (below) how a wholesale price is related to a lower rate.  In these cases, the wholesale price is the main determinant of interest rate for the consumer.

wholesalewithretailmargin

When presented with these options, we should choose to work with Mortgage Broker 2.  Due to their exclusive access to the lowest wholesale price (amongst the three), they will provide the lowest interest rate.

A lower interest rate results in lower monthly mortgage payments – who wouldn’t want that?

Retail margins differ between mortgage brokers

Mortgage brokers generate revenue only when they produce loans. All expenses, such as loan officer commissions, office overhead, and marketing/advertising, are paid for from this transactional revenue. As a result, each mortgage broker requires a different retail margin to maintain profitability and the range can be significant.  

Operational overhead is one of the most common reasons why retail margins range. A mortgage broker with a large executive team (drawing hefty salaries) will result in the need for larger retail margins.

A mortgage broker paying a hefty monthly “marketing expense” to a real estate office can also be a contributing factor. These monthly fees, called MSAs, are masked from compliance regulators by associating them with “joint marketing activities.”¬† While the legality of them may be increasingly questionable, the funds required to repay this large expense increases the retail margins charged.

Applying the logic from above, let’s take a look at how our Mortgage Brokers made out in a competitive environment.

DifferentRetailMargins

Mortgage Broker 2 ends up being the worst choice for a mortgage borrower.  The large retail margin results in the highest interest rate compared to both other options.

Mortgage Broker 3 ends up with the lowest rate for a mortgage borrower.  Their low retail margin means they can provide the best interest rate, resulting in the lowest payment compared to the other two options.

Shopping between mortgage brokers is vital

According to the Freddie Mac April 2018 Insight, shopping just one additional source for a mortgage can result in savings approaching $2,000.  Shopping up to five sources can result in savings that approach $4,000.

While these numbers may seem significant, we see rates vary by as much as 0.50% between mortgage brokers. This difference presents a more significant opportunity than the Freddie Mac April Insight suggests.

Because mortgage brokers can’t represent every single wholesale option and inevitably have a differing retail margin, they can only partially act in the best interest of a customer.

Despite advances in technology and efficiency, mortgage shopping is a vital part of the mortgage process and should be done in each and every instance.

Compare HELOCs using a margin

Why margins matter in a HELOC

Let’s take a look at what a margin is and why margins matter in a HELOC (Home Equity Line of Credit).¬† For the purpose of this post on April 20th, 2018, we’ll be using the HELOC page found here.

HELOC margins range

What we see on the HELOC page is that margins can range quite a bit. In some cases, margins are as low as -1.25.  Other margins show as high as +1.00.  What does this mean when it comes to a HELOC and why is it important?

A real-world HELOC example

Let’s take a look at an analysis for a client that may be interested in obtaining a $100,000 line of credit.¬† Here it is:

 

In this particular analysis, we will be comparing a “High Margin” and “Lower Margin” line of credit.¬† ¬†In both cases, the Prime Rate is the same because it is not set by the bank.¬† The margin, on the other hand, is set by the bank offering the line of credit.¬† This is where you see a range of options.

The High Margin HELOC

The High Margin HELOC shows a margin of 0.50 percent.  When we add this number to the prime rate, we can see that our effective interest rate is 5.25%.  This interest rate will be charged until the prime rate moves up or down.  Any movement in the prime rate will simply move the Interest Rate by the same amount.

In this specific case, a client borrowing $100,000 at a 5.25% rate will need to pay $437.50 each month.

Lower Margin HELOC

When we compare the lower margin line of credit, with a margin of -1.25%, we see that the same client may end up paying just $291.67 per month.  This lower margin results in a savings of nearly $146.00 each month.

2018 Tax Rules may make this more important

Historically, any interest associated with a line of credit could be written off against income. Said another way, a homeowner who obtained a line of credit wasn’t “really” paying the interest rate they were given.¬† This is because they were able to deduct the interest payments from their earned income and receive a tax refund as a result.

The new tax laws starting in 2018 have changed the laws for HELOCs.  Now, there are many instances where the interest paid towards a HELOC may no longer be tax deductible. Due to this, it is more important than ever to consider savings that may be available from a HELOC with a lower margin.

HELOCs for Wealth Management Clients

Next, let’s examine a $250,000 Home Equity Line of Credit.

 

 

The same margins from above show that a savings of $364.58 is possible between a high margin HELOC and lower margin HELOC.

Cost and Shopping HELOCs

Home Equity Lines of Credit are easy to obtain and the costs to obtain them are either $0 or less than a few hundred dollars.  All else equal, it is important to understand how shopping the margins between HELOCs can have a substantial impact on monthly free cash flow.

If you’d like to evaluate lines of credit in the Philadelphia area, go here.

Home Equity Line

How does a Home Equity Line Of Credit work?

When it comes to home finance, it pays to know your options. Homeowners looking to access cash often use a Home Equity Line of Credit (HELOC, for short). How a Home Equity Line Of Credit works is different than a traditional mortgage.

Let’s take a look at how they work and what they can do for you.

What is a HELOC?

A HELOC is a common type of second mortgage. Homeowners obtaining a HELOC often have a need for additional cash.  Typical uses are debt consolidation, home remodeling or accessing cash to purchase another property.

A unique structure

HELOCs are different because they have a unique structure. For the first 10 years, the loans are in a draw period.  During the draw period, homeowners can access any portion of the available cash on demand and pay only the interest on the funds in use each month.

During a draw period, homeowners can also pay back funds at any time.  If more cash is needed, the funds which were recently paid back can be accessed again.  In this sense, a HELOC is similar to a credit card.  Different from a credit card, however, HELOCs come with relatively favorable interest rates (only slightly above traditional mortgage rates).

Adjustable rates

HELOCs also come with adjustable rates that follow the prime rate published in the Wall Street Journal. Rates can vary each month and will be impacted by the prime rate and the margin (more on margin in a moment).

When the draw period ends after 10 years, a payback period begins. During the payback¬†period, funds can no longer be accessed from the HELOC. The outstanding¬†balance is converted to a regularly amortizing loan spread over 20 years.¬† Said another way, the balance is converted to a “normal” 20-year mortgage.¬† At the start of the payback period, the interest rate is typically fixed and will remain so during the next 20 years.

Shopping a HELOC

Virtually all banks, lenders and credit unions will use the prime rate as the core component of determining the interest rate during the draw period.¬† This is called the “index.”¬† A bank will also set a “margin” for the draw period. Banks may offer a promotional margin for an initial period.¬† For example, a bank may offer “Prime minus 0.50% for 6 months, then Prime plus 0.25% onwards.”

In this case, if the prime rate is currently 5%, the initial rate will be 4.5%.  It is important to note that if prime increases, so will the effective interest rate.  The promotional margin simply reflects a relative adjustment to the published prime rate.

Why a HELOC?

There are several reasons why you may consider a HELOC over a traditional refinance.

Maintain your great interest rate

It is no secret that mortgage interest rates have increased since their historic lows.¬† While they may still be low, rates in the 3% range¬†aren’t coming back anytime soon.

Homeowners looking to access additional cash may be hesitant to refinance out of their low rate Рand rightfully so!  The HELOC, as a second mortgage on the property, is a great option to maintain your first loan and still gain access to cash.  As a second mortgage, the loan operates independently of any first mortgage on a property.

Low costs to obtain

The transaction costs associated with a HELOC are significantly lower than a traditional refinance. The costs of a HELOC are typically limited to an appraisal (around $350).

In contrast to a traditional refinance that involves an appraisal, title charges, lender charges and other fees, HELOCs come out as a far less expensive option.

It is worth noting that many banks offering HELOCs will also require a borrower to open a checking account. If it is not a requirement to obtain a HELOC, it is often a requirement to obtain the promotional rate.

Flexibility

The flexibility provided by a HELOC during the draw period makes them extremely advantageous. In addition to the flexibility of taking money on demand, the flexibility to pay it back and draw again is unique. This is in stark contrast to “closed-ended” mortgages (like your first mortgage) where payments are made and funds cannot be withdrawn.

Flexibility also comes in the form of lower monthly payments.  For most HELOCs, the minimum required payment is equal to the interest accrued during the prior month. In contrast to a traditional mortgage that requires interest and principal, HELOCs provide for a significantly lower payment.

HELOCs also allow some or all of the principal balance to be paid off at any time with no penalty (unless stated otherwise in their terms). This feature allows HELOC borrowers to use them for short-term cash needs – such as cash to purchase and flip a house or buy a car.

Qualifying for a HELOC

Qualifying for a HELOC is similar to most traditional mortgage products.

A homeowner looking to obtain a HELOC will need to have good credit, documented income and some type of assets for reserves. Additionally, banks will require that the total amount borrowed against the home does not exceed 80% (or in some cases 90%) of the home value.

HELOCs can be a flexible way to obtain cash without disrupting a current first mortgage. With mortgage rates inevitably rising in the future, HELOCs will certainly maintain their place as a viable home financing product.

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Refinance when rates are up

Refinance when rates are up? Maybe.

Refinancing when mortgage rates drop is usually an easy decision.  A reduction in payment and the advantages of paying less interest can make great sense.  What happens when rates increase?  Does it ever make sense to refinance when rates are up?  The answer is “maybe.”

Let’s take a look at how amortization can be used to win when rates are up.

Amortization

In addition to the interest rate and loan amount, the loan term impacts your monthly mortgage payment.  Most mortgages are spread over 30 years or 360 months.  In these cases, the loan is amortizing across 360 payments.  The shorter the amortization time, the higher the payments will be when all else is held equal.  This is because the same debt will need to be paid off in a shorter period of time.

For an extreme example, assume you pay $100,000 in 10 equal payments.  Without any interest at all, you will pay $10,000 per payment.  Whoa. When the payment schedule is set to 360 months, the amount drops to just $278.  This, again, is without factoring in interest. The same loan amount spread over more months results in a lower payment.

Amortization can benefit you

When it comes to understanding how amortization can benefit you, an example speaks mountains of truth.  Let’s examine the pros and cons by looking at the Smith family’s options.  (Note: the Smith family is fictitious in this case).

Amortization Example

The Smith’s purchased their home ten years ago.  At the time, the home was valued at 300,000 and they put $60,000 down.  As a result, they started with a $240,000 mortgage.  Their mortgage broker was able to obtain a rate of 3.5% for a 30-year mortgage.  Their monthly mortgage payment has been $1,078 for the last ten years.  This amount does not include real estate taxes or homeowners insurance.

The Smith’s have been making regular payments without contributing extra on a monthly basis. As a result, the Smith’s have $185,000 remaining to pay in the next 20 years.

Increasing cash flow with a refinance

The Smith’s have decided it may be time to refinance. They wonder if reducing their monthly mortgage payment is possible.

They learn a new mortgage at 4.375% is available. The new mortgage doesn’t require the Smith’s to pay anything out of pocket but will increase their loan to $187,000 to cover some closing costs.

If the Smith’s obtain this new loan, they’ll reduce their mortgage payment to $933, saving about $145 each month.  While the Smith’s are interested in freeing up $145 each month, they wonder what else they have to consider when increasing cash flow in this way.

Extending the loan term

In the example above, the Smiths have determined they can save nearly $150 each month if they were to refinance.  They wonder if any issues exist with extending the loan term.

Each family’s timeline and needs are unique.  As a result, there is not a single answer to this question.  Let’s examine the Smith’s again to see what they come up with.

The Smith’s have lived in their home for ten years.  Now, with children in 3rd and 4th grade, they realize they’ve got just 12 years left until they are “empty nesters.”  At that time, they plan to move to a smaller home on the coast.  In light of this family plan, the Smith’s elect to continue with the refinance transaction.

Regardless of being in their old loan or a new loan, extending the loan term is not a major concern.  This is because they plan to sell their home prior to either mortgage being paid off in full.  The Smith’s elect to save $150 each month today because that was the best choice for them.

For more on saving money on mortgages – take a look at this recent post.

 

Purchase Mortgages MortgageCS

3 keys to understanding purchase mortgages

Wondering how to buy a home and don’t know where to start?¬† You aren’t alone in your quest to understand the home-buying process.¬† Those looking to buy a home can quickly become overwhelmed resulting in burnout.¬† The best way to avoid information overload is to walk before you run.¬† Here are the 3 keys to understanding purchase mortgages.

Key 1: What is a mortgage?

A mortgage loan is a loan that is used to purchase a home.   A borrower will obtain a mortgage from a bank or other lending institution in lieu of using all cash to purchase the home.  Just as someone could finance the purchase of a car, would-be homebuyers can finance the purchase of a home.

When a mortgage is used by a borrower, the bank or lending institution will place a lien on the property’s title.¬† This is not a bad thing! When mortgages are secured by a home’s title, they become less risky.¬† Lower risk means the banks will offer more favorable interest rates when compared to personal loans that are not secured by any property. Lower¬†interest rates¬†will translate into lower payments, and that is a great thing!

The exact term “mortgage” refers to a specific document that is created and recorded as a public record:

A mortgage is a legal document creating a lien on a property after an agreement is reached between a borrower and lender. The mortgage becomes a public record document at the county’s office and secures a property as collateral in consideration for funds borrowed.

How does a mortgage help homebuyers?

Without mortgage loans, buying a home with cash would be the only option. Yikes!

With mortgage loans, buying a home is much more manageable. Would-be buyers will use cash to pay only a portion of the home’s purchase price.¬† This is called the down payment.¬† It is also typical that a buyer will pay at least a portion of the closing costs out of their cash.¬† Take a look below for¬†a simple example regarding a $200,000 home purchase.

Purchase mortgages

 

In the example above, purchasing a $200,000 home results in a $160,000 mortgage and $50,000 cash required at closing.  This $50,000 includes $40,000 for a down payment and $10,000 as closing costs.

Key 2: What is a debt ratio?

Debt ratios matter a great deal when qualifying for a purchase mortgage.¬† The bank or lender requires proof that you can manage your soon-to-be housing payment. They’ll look for this proof by comparing your monthly debts to your monthly income and establishing a¬†debt ratio. Your monthly debts will be obtained from your credit report and your monthly income will be calculated using paystubs and recent W2 statements.

Once a debt ratio is calculated, it is typically converted into a percentage. A debt ratio that is too high will either restrict the loan programs you may have access to or disqualify you completely. Yikes!

Two different debt ratio calculations?

The front-end debt ratio examines all debts except for those associated with the new housing payment. The back-end debt ratio will examine all debts and include a soon-to-be housing payment. A back-end debt ratio below 43 percent is typically low enough to have access to virtually all loan programs. Once a debt ratio exceeds 43 percent, loan program availability will be reduced drastically.

 

MortgageCS Debt Ratio

Debt Ratio Example

Assume you earn $10,000 monthly and have a car payment of $400 and student loan payments of $400 each month.  Your front end ratio will be ($400+$400)/$6,400 = 12.5%.  This number is far below the typical requirement of 31% for FHA loan front-end debt ratios.

Add in a new housing payment of $1,600 and the back-end debt ratio becomes ($800 + $1,600)/$6,400 = 37.5%.  This ratio is approaching the limit for of 43% but still within a reasonable range to obtain access to most loan programs.

Important Tip: When calculating a debt ratio, mortgage lenders will use gross income (income before taxes). 

Key 3: What goes into a mortgage payment?

A monthly mortgage payment is typically made up of four key components: principal, interest, taxes, and insurance. These four items are commonly referred to as PITI.¬† Phonetically, PITI is pronounced “pity.”

PITI explained

Principal and interest will be calculated based on your starting loan balance and the interest rate associated with your loan.  Taxes refers to the real estate taxes associated with the property.  Insurance refers to the cost of the homeowners insurance required to protect the property. Homeowners insurance is a requirement when a mortgage is used to buy a property.  This is because the mortgage lender needs to ensure the collateral (your home) is protected.

 

Mortgage PITI

 

If you put down less than 20 percent of the purchase price when you buy a home you may need to add mortgage insurance to this number.  You also may need to add monthly association dues if you purchase a condo, townhouse or any property included in an association.  Since you know the basics of PITI now, these are simple to add to your monthly required payment.

What’s next?

You now have a firm understanding of mortgages, debt ratios and the components of a mortgage payment. Armed with this information, you can now continue your learning with ease – good luck!

save on your mortgage payment

Reduce your mortgage payment in 2018: 3 options

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Taking steps to improve financial wellness is a resolution for many of us. Families want to save more and spend less. Between student loan debt and cell phone bills, it can be challenging to find opportunities to save. Homeowners, however, may have several options within reach.  These are the three ways to reduce a mortgage payment in 2018.

Reduce your mortgage payment: 3 options

Want to spend less on your mortgage each month? Sure, who wouldn’t!?  There are a few ways to obtain relief.  Each option has important short and long-term considerations.

Re-cast your mortgage loan

Re-casting a mortgage restarts the mortgage term. Imagine for a moment that you have paid the first ten years of your 30-year mortgage. You will have just twenty years remaining. A recast would spread your remaining balance over thirty years rather than the current remaining term of twenty years. The result is a lower monthly mortgage payment.

Re-casting is different than refinancing.  A re-cast can only be done by the lending institution currently servicing your mortgage loan. It may involve a pre-paid interest fee or “re-cast” fee. The charge is typically far less than the cumulative fees associated with a traditional refinance transaction. Another important difference is that a re-cast will typically not require an appraisal.  For those that purchased a home at the peak of the market, this may be an important consideration.

Re-casting a mortgage loan will reset the mortgage amortization schedule.  [Why this is important] Using the example from above, you would extend your mortgage payments for ten additional years. Rather than paying your slightly higher mortgage payment for twenty years, you’ll pay a lower amount for thirty years. This can make sense for many, particularly those who are likely to move in less than twenty years.

Eliminate mortgage insurance

Mortgage insurance can be required on conventional mortgages or FHA loans. Homebuyers who currently pay mortgage insurance may be able to eliminate the requirement, saving money each month.

Homeowners interested in removing mortgage insurance must meet certain criteria. Depending on the type of loan, the current balance must be equal or less than seventy-eight or eighty percent of the home value. Said another way, homeowners will need to have at least twenty percent equity in their home. Because mortgage insurance can cost $100 or more, this can be a great way to free up cash flow.

The process of eliminating mortgage insurance involves interaction with your current servicing company. By speaking with them, you’ll learn what is needed and how much it may cost.  Your loan servicer may require an appraisal to confirm the current value of your home.  Your loan servicer may also use the value of your home at the time of purchase. Eliminating mortgage insurance is a simple way to save money each month.

Refinance your mortgage

Reducing a mortgage payment is most commonly achieved with a rate and term refinance. Homeowners will often reduce interest rates and extend loan terms providing for substantial monthly savings. Refinance mortgages are also flexible, allowing many goals to be achieved in one transaction.

The most common way to save money with a refinance is by lowering the interest rate.  All else being equal, a lower interest rate will require a lower monthly payment.  Since 2007, rates have remained relatively low which means most mortgages are already in the 3.5% to 4.5% range.  If your mortgage is in this range, you may not save money by reducing the interest rate alone.

Similar to a re-cast, refinancing into a longer term may also save you money each month in the short term. Similar to the example above, a loan extended from twenty years to thirty years will have a lower monthly payment with all else being equal. Extending the term of a mortgage can save you money each month even when the new interest rate may be higher than your current rate.

When refinancing a current mortgage, it is important to factor in the costs of the transaction as well as the long-term impacts. For example, those within twenty years of retirement may not benefit by obtaining a new 30-year mortgage loan. Additionally, a monthly savings of $50 or $75 may not be enough to warrant a rate and term refinance.  Each mortgage scenario is different, and several variables can impact the options available.

There you have it! Three ways to reduce a mortgage payment in 2018.

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Mortgage Amortization: tips and tricks you need to know

Mortgage Amortization: Tips and tricks every homeowner should know

There is no doubt that mortgages are a good thing. Homebuyers use mortgages to purchase real estate and current homeowners access cash using cash out refinance loans. These macro-benefits can be hard to dispute. Mortgages do have some less than desirable traits. One of these is mortgage amortization.

If this statement has you puzzled, then read on.  This information could save you time and money.

Mortgage amortization definition

Mortgage amortization¬†is the process of paying off a mortgage balance with regularly scheduled, equal payments. To ensure a solid understanding, let’s break this definition down into two parts.

“the process of paying off a mortgage loan”

The actual task of paying off a mortgage loan is similar to most other loans.  Homeowners send a check or set up a monthly draft to cover the required monthly payment. Homeowners make this payment over a period of time, called the loan term. The most common term for a mortgage today is 30 years (360 months).

Virtually all residential mortgages are paid off over several years.¬† Some mortgages can require full repayments, called balloon payments, at a specific point in the future. Balloon payments are not allowed for most residential mortgages, so we’ll focus on a traditional full term mortgage loans.

“with regularly scheduled, equal payments”

As mentioned above, mortgage amortization is associated with a monthly repayment schedule. Mortgage payments are due on the same day each month and lenders will dictate the minimum payment required in advance.

A monthly mortgage payment is made up of several different items. Some of these, such as property taxes and homeowner insurance premiums, can change over time. [What goes into a mortgage payment?]

We will examine the portion of the mortgage payment associated with paying down the mortgage debt.  To be specific, we will evaluate mortgage interest and mortgage principal payments only.

Mortgage amortization in action

With the definition of mortgage amortization behind us, let us step into the action!¬† By examining a typical amortization schedule, we’ll solidify our understanding and make some key discoveries.

Mortgage amortization example

For the example, we will use current data from the housing market. This will allow us to examine an amortization schedule for an average homebuyer in today’s environment. Here are the numbers:

  • New home purchase price*: $312,000
  • Down Payment Amount**: $15,600 (5% of purchase price)
  • Starting loan amount:¬†$296,400
  • Mortgage loan term: 30 years
  • Mortgage Interest Rate***: 4.00%

Given this information, homeowners will pay $1,415.06 towards interest and principal each month. Next, let’s examine how this payment is applied over the course of 30 years.

Mortgage amortization in the first year

Our average homeowner will make a mortgage payment in the amount of $1,415.06 each month.  (Remember that this amount does not include taxes, insurance and other potential items.)

In the first month, his payment will reduce the mortgage balance by $427.06 and pay the lender $988 in interest. The mortgage balance after the payment is $295,972.94.

1 month amortization

Key Discovery #1:  In the first month of paying a mortgage, this homeowner reduced his mortgage balance by just $427.06, despite making a $1,415.06 payment. Nearly 70% of the payment went to the lender in the form of interest.

Over the course of the first year, the homeowner pays slightly more towards principal each month.  He also pays slightly less towards interest each month. By the end of the first year, the homeowner pays a total of $5,219.69 towards his mortgage balance.  This represents just 1/56th of his beginning loan amount.

12 month amortization

Key Discovery #2: In the first year of a 30-year amortization schedule, 1/56th of the loan balance is paid, despite 1/30th of the 30-year loan term being completed.

To ensure this sinks in, ask yourself this question: If you obtained a 30-year mortgage, would you expect to reduce the balance by about 1/30th each year?¬† Seems logical, doesn’t it?¬†¬†Think again.

In actuality, you would not pay 1/30th of the loan in the first year. Rather, you would pay just 1/56th of the loan balance in the first year, leaving you with 98.3% of the loan to be paid in the remaining 29 years!

Let’s now take a look at the last 12 months of this same amortization schedule.

Mortgage amortization in the final year

Our homeowner has been diligent about paying his mortgage for 29 years.  With just 12 months left, he continues to pay $1,415.06 each month until the day the mortgage is gone.

You’ll find the last 12 payments detailed below.¬† In this final year of the mortgage, the homeowner pays a total of $16,618.45 in principal to eliminate his mortgage completely.

Mortgage Amortization last 12 months

Key Discovery #3:  This homeowner reduces the loan balance by 5.6% ($16,618.45) in the final year. This represents 1/18th of the balance, despite only 1/30th of the loan term being completed.

If the difference between the first year and final year hasn’t jumped out at you yet, let’s review the data.

First Year vs. Last Year

Comparing the first year to the final year of a 30-year mortgage amortization schedule exposes significant differences.

Amortization comparison

Notice that $11,398 more is paid towards the loan balance in the final year of the amortization.  Said another way, 3.85% more of the mortgage balance is being paid down in the same one-year time period.

Mortgage amortization favors your lender

So, how does the mortgage amortization schedule favor your lender?

Lenders collect the bulk of their interest early in the mortgage term. This results in a slow mortgage balance pay down for a homeowner. In the first year example above, the homeowner paid $16,980.72****, to find only $5,219.69 went towards the principal balance.

Homeowners receive no credit for “mortgage time served.” Homeowners who refinance a mortgage will find their new mortgage also starts from the same inefficient position detailed above.

Homeowners who sell and then buy a new home will experience a similar inefficiency. The first few years of mortgage payback while living in the first home will benefit the lender far more than the homeowner.

Tilting the scale in your favor

So what can be done to ensure your dollars are used efficiently?

Consider obtaining a shorter term

We evaluated the stark contrast between the first year and last year of a 30-year amortization schedule. Mortgages with shorter terms will be more efficient with respect to interest and principal payments.  They will also come with larger required monthly payments.

What if you want the benefit of a shorter term, but the flexibility to make lower payments when needed?  One option is to consider making extra payments on a 30-year mortgage term.

Consider making extra payments

Money paid in excess of the minimum monthly payment will be applied to the principal balance.  When the principal balance is reduced, future interest charges decrease.  We saw this happen in the examples above and we will be examining it here one more time.

Let’s see this in action using the first year’s amortization schedule.

12 month amortization

The homeowner makes his first six payments according to the schedule above. The 6th payment reduced his principal by $434.22 and paid interest of $980.83. He is now due for his 7th payment.

After picking up a lucrative side hustle, the homeowner decides to accelerate his mortgage payback. He reviews the amortization schedule, noting that his 7th and 8th principal payments are $435.67 and $437.12. He then adds $437.12 to his 7th mortgage payment, allowing him to skip the 8th month completely. As a result, the homeowner saves all the interest he would have paid in the 8th month: $977.94.

This is possible because a homeowner’s position on the amortization schedule is determined exclusively by the remaining principal balance. Accordingly, the homeowner can continue to add money to his payments and¬†accelerate his mortgage payoff, saving thousands in interest along the way.

 

 

Data Sources:

Legal Disclaimers:

  • Tax implications or considerations are not included in this review
  • This is for illustration purposes only – loan terms will vary for each homeowner
  • This is not an offer to make a loan in any form