The amount of interest you pay on your home mortgage may have the biggest impact on your personal finances over your lifetime.
Not sure you believe me? Well, consider this example:
I really like Bankrate’s website, and the site provides a simple home mortgage interest calculator. Let’s assume that you’re buying a $300,000 home loan, putting down a $15,000 cash deposit and borrowing the remaining $285,000 for 30 years. At a 5% rate, your payments are $1,529 a month. If, instead, you have to pay 6.5%, your monthly payment is $1,801 a month.
Think about it. At 6.5%, your paying $272 more per month. Assuming that you never refinance to a lower rate and own the house for the entire 30 years, you’re paying $272 per month for 360 months, or an additional $97,920 over the life of the loan. It’s a huge number- imagine if you could pay the lower 5% and invest the $97,920? Staggering.
So, if you buy my argument that lowering your home mortgage interest rate can make a huge impact on your finances, let’s talk about what we can do to lower the rate:
Caution: Interest rates are trending up
So the solution for many borrowers is to refinance when interest rates go down. Using the same example, assume that 30-year mortgage rates for people with your credit score (more on that later) fall from 6.5% to 5%. You refinance, which allows you to lower that monthly payment- problem solved.
Well, not so fast. After decades of decline, interest rates have bottomed out and may start to climb. This first chart shows how mortgage interest rates have steadily declined until recent years. The second chart explains how CD interest rates have bottomed out after years of decline. As banks earned less on mortgage loans, they paid less on deposits. Loan and deposit rates move together.
This also has an impact on borrowers with variable rate mortgages. If interest rates are trending up over the long-term, variable rate loans will reset at higher interest rates, so watch out.
If you can’t “bank” on refinancing, you need to move on the issue of your credit score.
Understanding- and improving your credit score
I’ve written several blog posts about credit scores, including this one. There are some key points to keep in mind as you work on improving your credit score:
- Using some amount of credit is good: Borrowing money and paying it back shows a potential lender that you’re reliable. So it makes financial sense to have some debt- as long as you can consistently make the payments.
- Applying for credit impacts the credit score: When you apply for credit, it’s factored into your credit score, so be mindful of that fact. Applying for one credit card is great, applying for five will hurt your score.
- Credit reporting agencies must correct reporting errors: Recent legislation to protect consumers includes tougher requirements for credit reporting agencies- the companies that collect data and calculate credit scores. If you find errors in your credit report (maybe an outstanding balance that has been paid in full), follow the guidelines to get the info corrected. These agencies are obligated to report accurate credit information.
Each of these steps can help you improve your credit score and secure a lower home mortgage interest rate.
Use the tools available
Like many things in life, there are resources out there to lower your mortgage interest costs, if you do a little digging. Here are several:
- Conventional 97: This is a mortgage program that allows certain buyers to make a down payment of only 3%, while still paying a reasonable rate of interest.
- FHA Loans: The Federal Housing Administration (FHA) insures these types of mortgages, which reduces the lender’s risk of default and allows the borrower to avoid paying for private mortgage insurance (PMI). This is huge, because PMI can add 1.5% to the total borrowing amount of your loan.
- VA Loans: If you’re a veteran, the Department of Veterans Affairs (VA) can partially guarantee a veteran’s home loan, which also can eliminate the need for PMI. In some cases, you can purchase a home without a down payment.
Lowering your home mortgage interest rate can have a massive impact on your finances over time, so use these tips to lower your rate. As always, these posts are for informational purposes only. Consult a financial, insurance or tax advisor as needed.
Author: Cost Accounting for Dummies, Accounting All-In-One for Dummies, The CPA Exam for Dummies and 1,001 Accounting Questions for Dummies
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