What’s your biggest expense? If you’re like most people, it’s putting a roof over your head. And it’s getting more expensive.
In fact, the cost of housing is rising faster than incomes for the middle class, according to a National Housing Conference report. Renters may have the worst of it; the Wall Street Journal reports that rent has been rising for 23 consecutive quarters.
By buying a house, you have more control over rising housing costs. You won’t have to worry about a landlord raising the rent, and a fixed-rate mortgage loan guarantees the same principle-and-interest loan payment for the next 30 years.
Yes, borrowing for a home is expensive. Fortunately, with a few smart strategies, you can reduce your monthly mortgage payments and cut the overall cost of paying for your home. Here are some options:
1. Modify Your Loan
If you are late on payments or going through tough times, you might qualify for a loan modification through various programs.
Depending on the program, you could qualify for a reduced interest rate, forgiveness of part of the principal, or an extended loan period and lower monthly payment. Check out various programs on MakingHomeAffordable.gov or contact your mortgage servicer.
2. Cut Out the PMI
If you borrow more than 80% of the value of your home, you normally have to pay for private mortgage insurance (PMI) to protect the lender. PMI typically costs between .5% and 1% of the loan amount. So if your loan balance is around $140,000, you could be paying as much as $1,400 for PMI just this year.
A down payment of 20% is the most obvious way to avoid paying for PMI. If this is tough with the homes you’re considering, Realtor.com suggests simply shopping for lower-priced homes for which you can make a 20% down payment. Multiply the down payment you have by five to arrive at the highest price you can pay while avoiding PMI.
Credit.com says some lenders still offer 80/10/10 programs. This structure allows you to borrow only 80% on the primary mortgage, so you don’t have to pay for PMI, and then borrow another 10% as a second mortgage loan — sometimes from the same lender. You generally need a credit score of 700 or higher to qualify.
If you’ve already bought your home, you can speed up those payments to get the balance below 80%, and then request that the PMI payments be dropped. Lenders do not always agree to drop the insurance requirement, according to BankRate.com, but at that point you could also refinance to get rid of the PMI.
The law says a lender has to drop the PMI at the point when you are scheduled to reach a balance of 78% of the home’s value at the time of purchase, as long as you’re making the payments on time. If you are at that point, check to make sure the PMI has been dropped.
3. Buy a Less Expensive Home
Buying a less expensive home not only opens up the possibility of a 20% down payment, which eliminates the cost of PMI, but it also reduces many other costs.
Payments (and interest charges) will be lower on a smaller loan. In addition to the lower direct loan costs, you’ll save money on property taxes and insurance. If it’s a smaller house (not just cheaper), you may also save on maintenance and utilities.
If you already own a house but want to cut costs, consider downsizing your home. You can reduce your payments, eliminate mortgage insurance and probably cut other expenses as well.
Selling your house and buying a less expensive one works especially well if you have substantial equity, since you can put much of that toward the new home to keep the loan amount (and payments) lower.
5. Refinance Your Mortgage
Before you refinance, you have to be clear about your goal. Is it just lower payments you need, or do you want to lower your long-term costs? Or are you looking to do both?
For example, if you have 13 years left on a 15-year, $140,000 loan at 4.5% interest, you owe about $126,000 and have payments of $1,071. A loan calculator shows that a new 30-year loan for that amount at 6% drops that payment to $839, or $232 less per month.
The downside: You’ll pay $302,173 over those years, versus $167,076 if you stuck with the old loan and faster payoff. That’s $135,097 extra for the convenience of lowering your payments now. So do you want to pay less over the years or just have lower payments right now?
You also have to be careful about loan costs. Surprise fees are one of the primary complaints from borrowers, according to a recent survey. Apart from loan costs, you may have to pay for an appraisal, recording fees and taxes in some states. Ask lots of questions to determine as closely as possible what the total cost of refinancing will be.
Once you calculate your cost to refinance, you can determine your break-even point using a refinance calculator. For example, with a current balance of $140,000 on a 30-year loan taken out in 2009 at 5%, refinancing at 4% with $2,500 in loan costs leaves you with a break-even point of 31 months. That’s when your savings in interest paid will have covered the costs of refinancing.
If you move (and sell) before your break-even point, you’ll have lost money by refinancing. On the other hand, in this example, if you stay for another 30 years you’ll save $17,562 total — not bad for a few hours of paperwork.
Curious about refinancing? Click here to see a table with the best refinancing rates in your area.
6. Reduce Property Taxes
Although property taxes are not technically part of the loan, payments often include money that’s put into escrow to cover property tax bills and insurance.
If you think your home is worth less than the assessor says, ask for a review. You might need to try a few tricks to getting the assessment changed and lowering your property taxes, but if you succeed your lender should adjust your payment to reflect the lower annual bill.
7. Buy Cheaper Insurance
If your mortgage payment includes an escrow amount for home insurance, you can get it lowered by finding a cheaper policy. Of course, even if it isn’t rolled into your house payment, you can save money by finding better insurance rates.
Lenders have minimum requirements for homeowners insurance, so the policy you buy must meet their criteria.
8. Make Extra One-Time Payments
If you get a big tax refund or a gift or small inheritance, you can put a chunk of it toward your mortgage loan.
If you pay an extra $1,000, the balance of your loan will be $1,000 lower than it would have been for every remaining month. For example, if the interest rate on your loan is 5%, you’ll save $50 in interest every year until you make the final payment. That adds up!
9. Make Regular Extra Payments
If you can afford to add more to your monthly payments, this is one of the surest ways to reduce your interest charges over the years. A loan payment calculator can show you how much you’ll save with regular extra payments.
As an example, if you have 30 years to pay on $140,000 at 5%, and you add $356 monthly to your regular $751 payment, you’ll pay off that loan in half the time and save $80,000 in interest.
Of course, you could also save on interest by getting a 15-year loan to start with. But by paying extra on a 30-year mortgage you get the same effect, and you can stop paying the extra amount if you run into financial difficulties.
10. Use Credit Card Offers
Do you ever get 0% interest credit card offers? If so, you can use them to reduce the mortgage loan interest you pay. For example, suppose you’re paying $400 extra monthly on your 5% mortgage loan and you can get a card with 0% interest for the first year and a 2% fee the convenience checks (often this is 3% or even 4%). Here’s what you can do:
- Step 1: Write a check to your mortgage servicer for $5,000 (that’s approximately what those $400 payments add up to in a year) and pay the $100 fee.
- Step 2: Put the $400 that was going toward the loan into a savings account each month and pay the minimum on the credit card from it.
- Step 3: In a year (when the promotional rate ends), use the savings account to pay off the remaining balance on the card, and put the rest toward the mortgage loan.
By using this strategy, you’ll earn interest in the savings account (1% in a good account, or as much as 3% in a Kasasa account). More importantly, you’ll reduce the loan balance by $5,000 right up front instead of spreading it out over the year. You’ll save $250 in interest charges (5% of $5,000) and make $25 to $50 from the savings account.
Even after the $100 fee, you will have reduced your total cost by $175 to $200, which is more than the $46 you would have saved on interest by just paying the extra $400 monthly.
This form of credit card arbitrage is sometimes called “stoozing,” and is best done only if you’re very disciplined and organized. The penalties and interest from a late payment on the credit card, or from forgetting to pay it off in full after the 0%-interest period ends, will quickly wipe out any advantage gained.
Your Turn: Have you used any of these strategies for reducing your mortgage costs?