Even if you love your house just the way it is, chances are there’s one thing you wouldn’t mind changing: the size of your mortgage payment.
Lower your mortgage loan payment and lots of things get easier. From making ends meet more easily to attacking other debt to saving for the kids’ college or that special vacation, shrinking the size of that mortgage could be life-altering.
Read on for tips that could have you doing a lot more than just dreaming of two weeks in Hawaii.
When the rates are right, refinancing your mortgage can lock in payment relief for the life of your loan. Have you noticed? In the spring of 2020, rates have never — never, never, NEVER! — been better.
If it seems the forces of nature and human discontent aimed to knock the economy off its axis, one of the areas it missed is mortgage interest rates. As billions of dollars seeking safety in the COVID-19 storm poured into 10-year U.S. Treasury notes, the return sank to record-low territory, hovering much of the time below 0.7%.
Mortgage rates, which are tied to the 10-year Treasury, tumbled, too. Week after week through late winter into June, Freddie Mac, Fannie Mae, and the Mortgage Bankers Association reported one record-low rate after another. The upshot: Refinancing accounted for two-thirds of all mortgage activity.
And, reported Freddie Mac Chief Economist Sam Khater, the average refinanced loan balance shrunk in May by $70,000 — meaning it’s not just high-end homeowners who see the benefits of refinancing; this coronavirus share-the-wealth plot twist means opportunity for homeowners of modest means, too.
Whether rates will drop even further — or suddenly rebound — is anybody’s guess. It bears noting, however, that with plummeting interest rates and surging applications to refinance, lenders are ramping up their qualifying standards. Expect to encounter tighter income, credit-score, and down-payment conditions.
A variety of ways exist to refinance. Let’s have a look.
A cash-out refinance replaces your existing mortgage with a new home loan that is somewhat more than your original mortgage balance. The difference — the cash-out portion — comes to you to spend as you see fit (although the lender may ask) on things like home improvements, debt consolidation or the kids’ college fund.
The cash comes from your home’s equity: the margin between your loan balance and the present value of your property.
Most likely, the lender will limit you to some portion of your equity — generally around 80% of your home’s total value. If your house appraises at $300,000 and you owe $200,000, you can expect to borrow up to $240,000. Any higher and you’re likely to trigger private mortgage insurance premiums.
You would use the $240,000 to pay off the balance of the original loan — $200,000 – leaving you with a net of $40,000 to do with whatever you want.
This is pretty much the opposite of a cash-out refinance. Instead of taking extra cash out, you put extra cash in, thereby reducing its balance. A lower interest rate on a smaller balance means savings on top of savings each month. … Just be certain that cash wouldn’t be better invested elsewhere.
Extending your loan term will lower payments. Say you’ve been paying down a 30-year mortgage for 10 years or more. Refinancing the existing balance into a fresh 30-year term would slash your payments, even if your interest rate didn’t budge. If rates have dropped, your payments would contract even more.
The downside, of course, is you’ll add a decade or more to your repayment period.
At the risk of stating the obvious, if you’re struggling with the payments on a 15- or 20-year mortgage, refinancing to a 30-year term will save you hundreds every month, even as your interest rate bumps up.
In other words, add a few years to your mortgage — by paying a small fee to your lender. You get the immediate benefit of refinancing — a shrunken payment — without the hassles and costs of applying for a new loan.
The downsides are daunting:
Bottom line: There are better, wiser ways to lower your mortgage payment.
Shortening the loan term can get you a lower interest rate, build equity faster, and pay off your mortgage sooner. Of course, by compressing the life of your loan, your payments will go up, not down, but you’ll own the home much sooner.
Private Mortgage Insurance (PMI) protects the lender — not you. The biggest worry a lender faces is default and foreclosure. Foreclosing on a home isn’t cheap for the lender and can take months while the house is in legal limbo and not producing any income. So, lenders want to cover themselves with insurance, and they make you pay for it.
If you bought your house with less than a 20% down payment, chances are you’re paying private mortgage insurance — PMI — in addition to your regular loan payment. There are a couple of ways to unload your PMI premium.
The first, less exciting way, is simply to keep making payments and when you have whittled the balance to 78% of your original loan, by law, PMI goes away.
Take it from someone who has known this joy: The second is far more satisfying. Keep an eye on home values in your neighborhood. As they (presumably) rise, the equity in your house rises, and usually at a rate substantially faster than your loan balance is shrinking.
When your home’s value has swelled sufficiently that you have a 20% equity stake, you may ask your lender to cancel your PMI … and your lender must comply.
Homeowners may forget the role taxes play in how much money goes into escrow. Review your annual property appraisal to determine whether it fairly reflects the value of your property.
Visit the property assessor’s website to review the values assigned other properties near you that are comparable to your home. If they are assessed for less, or if recent sales suggest property values are dropping, you can, and should, appeal your assessment.
Instructions for how to appeal your appraisal also can be found on the property assessor’s website.
Remember: The assessed value of your property isn’t its market-appraised value. The tax assessor establishes the assessed value independently. If the collector refuses to reassess your home and you have evidence that the assessment is inflated, you can file a complaint with your county government and can request a hearing with your state’s Board of Equalization.
Mortgage lenders require you to maintain replacement-value insurance on your home to protect their loan. But there are usually multiple insurance companies willing to write a policy, and some charge less than others for equivalent coverage. Periodically check with other insurers to make sure you have the best deal, and do some rate shopping to lower your homeowners’ insurance if you don’t.
Study the various clauses and riders, too. Make certain you’re not buying more coverage than you need.
Hint: Check with the company that insures your car. Companies often offer discounted bundled rates if you have more than one policy.
Some mortgages allow you to pay interest only during the initial period. For instance, if you have a 30-year mortgage, the lender might require interest only for the first five years. At the end of the interest-only period, you begin paying principal and interest; count on your payments rising dramatically.
Carefully calculate whether you will be able to afford the future increase before taking such a loan. Additionally, an interest-only loan makes sense only if conditions indicate the value of your house will rise quickly.
If you’re paid every other week, paying half your mortgage payment each time your check is deposited might make sense for your budget.
Not that this will lower your monthly payment, but it will do three other beneficial things:
The magic is in the two extra payments you send (26 every-other-week payments), creating the equivalent of a 13th monthly payment, the last going entirely toward principle.
If this is your forever house, making biweekly payments on a 30-year fixed-rate mortgage will shrink your loan between five to eight years, saving tens of thousands of dollars in interest.
If it’s a house you’ll be leaving after a few years, a biweekly plan — assuming it doesn’t over-stress your budget — will mean you recoup more equity when you sell.
You can enter into a biweekly payment plan on your own; you don’t need the lender’s cooperation, or to enter into an expressed plan (and the fees that go with it). Set up an autopay command for your checking account, and away you go — although you may need to remind the lender about the last two payments of the year are to be applied against principle.
If you have extra space – especially if your house has a guest wing – consider renting out a room. This could mean extra income that can offset your mortgage, tax, insurance and maintenance costs. This solution might work best if you know the tenant and can negotiate agreeable terms.
Another option, but only if you are a small business owner or self-employed and work from home, is to designate a room as a home office. You can deduct the room on your income tax return if it is used exclusively for business.
What about if your employer has you working from home to help “flatten the curve” during the COVID-19 pandemic? Sorry. If you are a W-2 employee, your opportunity to claim a home office deduction evaporated with the 2017 tax plan.
Contact a tax adviser before doing this, and be prepared to keep meticulous records. We’re not suggesting you shouldn’t do this. But few deductions trigger alarm bells faster or louder at the IRS than claims for a home office, so your case must be solid.
You’ve been a model borrower. Never missed a payment. Never been late. But you took out your loan in early 2011, and you’ve been pounding away on a 5% interest rate ever since. Now rates are almost two points lower.
But refinancing is a hassle — proving your income, having your credit score probed, putting up with an appraisal, parting with some of your savings.
You’re thinking, maybe, if you ask, your lender will cut you a break.
Better think again.
Lowering the interest rate on a well-performing loan without refinancing is next to impossible. Instead, you have to be in trouble for your lender to listen, and even then, you’re looking only at some of the less-desirable loan modification methods mentioned above.
Sometimes, people wind up with more house than they can afford. (See: Schitt’$ Creek, POP TV.) If you decide that you can’t afford your home and other strategies won’t work, consider selling.
Staying in a house you can’t afford can lead to heartache, sleepless nights, and to default — the worst outcome for your finances. If you sell, you can use the proceeds to buy a less expensive place, or you could invest the money and rent. Remember to factor in a real estate commission if you use an agency to sell your property.
If your mortgage-payment struggles are part of an overall problem with your finances, look for ways to trim your spending. Establish, or re-establish, a budget, being mindful — but realistic — about where you can trim spending.
If you’re choking on your mortgage payment as a result of the coronavirus shutdown, you have options, especially if you have a federally backed loan. Under the Cares Act, loans owned by Fannie Mae and Freddie Mac, or guaranteed by the Department of Veterans Affairs, Department of Agriculture, and the Federal Housing Administration, must grant deferred or reduced mortgage payments for up to six months, plus an additional another six months upon request.
Check with the Consumer Financial Protection Bureau for guidance about how to manage your mortgage if coronavirus has knocked your finances off a cliff, and you can’t afford your bills.
Otherwise, get a strategy. Prioritize your bills. Create and stick to a budget. Investigate areas of additional income. Contact your lenders.
Look to your utilities for savings. There’s low-hanging fruit in your water, electricity, and gas usage.
If you’re bailing as fast as you can but you’re still taking on water, consider involving a credit counselor. These are experts trained to help folks evaluate their debts — they’ve seen worse than yours — make recommendations, and sometimes create a debt management plan that charts a course to a smooth-sailing future.