How to Save Money on a Home Mortgage Loan
8 Easy, Simple Ideas When You Borrow Money
When you need a home mortgage loan, you can save money if you plan ahead and comparison shop. With interest rates so low, now is the best time to borrow money for a new home. Here are easy, simple guidelines.
Make a bigger down payment to save money on a home mortgage loan. Your loan will cover about 80% of the purchase price of a home. You should have savings to pay at least 20%.
- As a rule of thumb, you can afford a house if the monthly mortgage payment, plus insurance and real estate taxes, are less than 28% of your gross income.
- You can save money with 12-year or 15-year mortgage, compared to a 30-year mortgage, but your monthly payments will be higher.
- A variable interest rate is initially lower than a fixed interest rate. Choose a variable interest rate to save money, or choose a fixed interest rate for security because you anticipate that interest rates will go up.
- Ask the lender if you can save money with a government insured mortgage, like a VA loan.
- To save money on a home mortgage loan, use the APR, the True Annual Percentage Rate to compare loans from different lenders.
- Ask each lender for the Good Faith Estimate, which shows all the closing costs you will be charged for the home mortgage loan.
- You can save money by negotiating for better terms from the lender.
What Is a Home Mortgage Loan?
The home mortgage loan is a legal contract. The mortgage contract indicates that a specific amount of money is loaned at a specific interest rate so that you can buy your home. The mortgage gives the lender a legal claim against your house should you default on your loan payments. In some states, the home mortgage loan is called a deed of trust.
The lender provides you money to buy a house. In exchange, you agree to repay the lender the loan, plus interest, usually in monthly paymets. You also agree to pay the real estate taxes, to pay for property and liability insurance, and to maintain the property. If you default on the terms of the mortgage, the lender can ask you to repay the entire loan immediately. If you do not make the monthly payments, the lender can foreclose on the property.
There are four reasons you might need a home mortgage loan:
Where Can I Get a Home Mortgage Loan?
- to purchase a new home
- to refinance your existing home
- to cash out the equity in your home
- to consolidate your various debts, including an existing mortgage
Many companies are in the mortgage business, including commercial banks, thrifts, and other institutions. The bank where you have your checking and savings account probably has a mortgage lending department.
Save Money With a Government-Insured Home Mortgage Loan
Some lenders offer home mortgage loans backed by a federal agency such as the Federal Housing Administration (FHA loans) or the Department of Veterans Affairs (VA loans). With these loans, the government insures the lender against default. Insured mortgages may offer lower down payments on entry level homes. When you're shopping around, you will find that there are special programs to assist veterans, people with disabilities, Native Americans on tribal land, low-income buyers, buyers of houses in rural areas and first-time homebuyers. Ask the lender if such programs are available.
Loans that are not government-insured are called conventional mortgages. The majority of mortgages are uninsured conventional mortgages.
How Much Mortgage Money Can I Borrow?
As a first estimate, you can buy a home worth about 3 times your total yearly gross income. This assumes that your down payment is 20% of the price of the home.
Lenders often use the "28 and 36" test to see how much house you can afford. The total housing expenses, including mortgage payments, real estate taxes and home insurance, should be less than 28% your gross income, before taxes. Payments on all your debts, including the mortgage payment, should not exceed 36% of your gross income. When you talk to a lender, find out what ratios will be used to evaluate your application.
Fixed Interest Rate versus Adjustable Rate Home Mortgage Loan
Your lender will talk about a variety of mortgage products, but in reality, there are only two types of mortgages: fixed-rate and adjustable-rate.
With a fixed-rate mortgage, the interest rate and your monthly payment remain unchanged for the life of the loan, or until you pay off the mortgage, refinance or sell your home, whichever comes first.
On an adjustable rate mortgage, ARM, the interest rate changes periodically, which means that your monthly payment changes, too. If the interest rate rises, your payments will go up. If rates fall, your payments could go down. An adjustable-rate mortgage, ARM, usually starts out with a lower rate than a fixed-rate mortgage, and therefore a lower monthly payment. The interest rate adjustment period occurs every one, three or five years. The interest rate on an ARM might be set several percentage points above a major published interest rate, such as the prime rate or the London Interbank Offered Rate, LIBOR. Every time the interest rate is adjusted, your monthly payments change, too.
No one can predict what future interest rates will be. With an adjustable rate mortgage, you are gambling that future interest rates will not increase significantly, and that you will be able to make the monthly payments. However, interest rates are low now, and historically, interest rates have been higher. For example, in 1980, the interest rate for a 30-year fixed mortgage was over 13%, double what it is today.
If you expect to live in the house three years or more, you are advised to get a fixed-rate mortgage. A variable rate mortgage might be appropriate if you plan to resell your house in a few years. If you are considering a variable rate mortgage, find out if there is a ceiling on the interest rate you will be charged. Find out if your interest rate can be increased, even when the prime rate has not increased.
Hybrid adjustable-rate mortgages have the interest rate fixed for a short time, usually three, five, or seven years. Then the interest rate switches to a variable rate.
Use the True Annual Percentage Rate to Comparison Shop
In addition to the interest, there are closing costs and fees for a home mortgage loan. The lender is required by law to tell you the Annual Percentage Rate, APR. This is the true cost of the loan because it takes into account, not only interest, but the fees and points the lender also charges. When you evaluate the offers from lenders, compare the APRs and also the other fees.
The costs included in the APR are spread across the entire term of the home mortgage loan, in most cases, thirty years. Yet very few homeowners keep their mortgage this long. So if you refinance or move in five to seven years, the mortgage with high up-front costs will be more expensive than the 30-year APR. The APR can also be computed for a 7-year holding period, or a 10-year period, to give a realistic cost for your situation.
Another thing to consider is that APR is not accurate for adjustable rate mortgages, since it’s impossible to predict what rates may do in the future.
The lender will also provide a Good Faith Estimate, GFE, showing the loan origination fees, appraisal fees, title search and other fees, which you can use to compare loan offers. You have the RIGHT to ask for a Good Faith Estimate of all loan and settlement charges before you agree to the loan and pay any fees. You have the RIGHT to know how much the mortgage broker is getting paid by you and the lender for your loan. You have the right to ask questions about this report and to negotiate for better terms.
Save Money by Shopping for a Home Mortgage Loan
To save money on a home mortgage loan, you should contact multiple lenders to compare loan offers side by side. Remember, the lender is selling you a product. If you have good credit, you will be in a strong negotiating position. You can shop for the best interest rate. You can negotiate many of the closing costs. The lender is not doing “a public service.” You have the RIGHT to shop for the best loan and save money when you compare the terms of home mortgage loans.
To make your decision, compare the Annual Percentage Rate, the APR. Then review the other fees to see that they are comparable to those of other lenders. Another factor in your decision is the size of the down payment the lender requires. A larger down payment saves you money two ways. First, a larger down payment reduces the amount of money you need to borrow. Second, if you make a larger down payment, you can get a lower interest rate.
Save on Points for a Home Mortgage Loan
Points are additional interest paid at the closing. When you pay points, you are essentially paying the lender a portion of the interest up front, in return for a lower interest rate over the life of the loan. A “point” equals 1 percent of the loan amount. Every point you are charged adds .125% to the APR. By paying a point at closing, you can lower the stated interest rate by about 0.125 percent. So if the interest rate is 6.5 percent, you could lower it to 6.375 percent by paying for one point.
Should You Pay Points to Lower the Interest Rate?
If you intend to hold the mortgage only for a short period of time, the cost you pay up-front will exceed the benefit you’ll receive from a lower rate. To get an idea of whether or not it is worthwhile to pay points, divide the amount paid in points by the amount saved in lower monthly payments.
For example: If you are borrowing $100,000, you can pay no points for a 7% loan for 30 years, which is roughly $665 per month. Or you can pay 2 points for a 6.5% interest rate, which is roughly $632 per month. Your savings per month would be $33 ($665-$632).
One point is one percent of 100,000 or $1,000. The amount you pay for two points will be $2,000. So, paying $2,000 in advance saves you $33 on your monthly payment, that is, $396 a year. Is this a good idea? Only if you stay in the house more than 5 years.
Private Mortgage Insurance
If your down payment will be less than 20% of the value of the home, lenders will require that you pay for private mortgage insurance, PMI, at the closing. Private mortgage insurance protects the lender against your default. The cost of PMI is also included in the true Annual Percentage Rate, APR.
How Much Are My Monthly Payments on a Home Mortgage Loan?
How much you pay every month depends on two things, the interest rate and the length of the loan. The higher the interest rate, the higher your monthly payments are. If you take longer to repay the mortgage, your monthly payments are less, but the total interest paid over the life of the loan increases. This table shows your monthly payment, assuming a $100,000 mortgage. If your mortgage will be $200,000, which is 2 times as much, just double the monthly payment shown in the table.
|For a $100,000 Mortgage ||Interest Rate 5%||Interest Rate 6%|
|Monthly payment for 15 year loan||$790||$843|
|Monthly payment for 30 year loan||$536||$599|
|Total interest paid on a 15 year loan||$42,343||$51,893|
|Total interest paid on a 30 year loan||$93,256||$115,838|
The Closing Cost of a Home Mortgage Loan
Some lenders may ask you to pay an application fee when you apply for the mortgage. They may ask for a “lock-in” fee, so that they won’t raise the interest rate on you before the closing.
At the closing, you will pay closing costs. Often the closing costs are included in your mortgage, and you are borrowing the money to pay them. In some states, the closing is called the settlement. You will receive a copy of the HUD-1 Settlement Statement, which lists everything the buyer and seller will pay at the closing. Here are some likely closing costs you will pay:
It is likely that your home mortgage loan will be sold to another institution, so don’t expect to be dealing with your original lender over the life of the loan.
- loan origination fee. A loan origination fee of 2 points means that you are charged 2% of the mortgage amount as an additional fee.
- loan discount points. Discount points are additional funds you pay the lender at closing to get a lower interest rate on your mortgage. Discount points are included in the true Annual Percentage Rate.
- appraisal fee. An appraisal is made of the property to see that the mortgage is adequately secured. It protects the lender.
- private mortgage insurance (PMI). Most lenders require PMI if your down payment is less than 20 percent of the home’s value. PMI is also included in the APR equation.
- fee for the title search. A title search is made to be sure that the deed can be transferred to you.
- credit report fee. The lender orders your credit reports from three major credit bureaus, to determine your credit worthiness, to verify the information provided on your loan application and to decide what interest rate to offer you.
- assumption fee. If you are assuming the seller’s existing mortgage, the lender will require a fee for this.
- prepaid interest. Interest on your mortgage from the date of the closing to the date of your first regular payment is computed and charged at the time of the closing.
- escrow account payment. An escrow account is money deposited to pay real estate taxes and insurance. You will make the first escrow payment at the closing. A portion of each monthly payment is put into the escrow account to cover taxes and insurance as they come due.
In some states, escrow is also known as "impounds" or "reserves."
- The fee to transfer the title and record the deed.
- Costs of a home inspection and a satisfactory termite inspection.
- The cost of the title search, title insurance if necessary, and survey of the land may also be billed to you at closing.
- Homeowner’s insurance. You will arrange for it and pay for it out-of-pocket. The lender will ask for a copy of this insurance policy.
- Real estate property tax. This tax is prorated from the date of closing to the date of the next regular tax bill. The seller generally pays this amount to the buyer.
- The down payment.
- The good faith money, put into escrow at the time you made the offer to buy the house, is returned to you. You can use it as part of the down payment, and the lender provides the balance of the purchase price.
- The home purchase agreement may specify that the seller pays the buyer at closing an allowance for repairs and improvements on the property.
- The seller, rather than the buyer, will pay the real estate broker commission at the closing.
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