The excitement of homeownership is often countered by the burden of long-term debt. Imagining life in 30 years, still forking out hundreds or thousands of dollars each month, can be an overwhelming thought. Each loan has unique terms, but most allow a few options for homeowners to save money on the total cost of a mortgage.
Pay Extra Toward the Principal
The most common strategy to save money on a mortgage is to pay it off ahead of schedule. This technique allows owners to avoid a great deal of the cost of interest and shorten the life of the loan. Homeowners who plan to save money on their mortgage by paying it off early should consider these tips.
Some loan servicers charge penalties for prepayment. Others charge a penalty for extra payments during the first year of the loan. To avoid fees, look into the loan terms before making additional payments.
Specify that the additional funds should be applied directly toward the principal balance. Otherwise, the funds will likely be attributed toward interest. Although extra interest payments will reduce the total length of the loan, they will not reduce the total cost. Paying off the principal reduces the amount of interest due and simultaneously shortens the length of the loan.
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It’s always a good time to apply extra funds toward the principal; however doing so during the first few years of a loan is most beneficial to the homeowner. Monthly mortgage payments consist of more interest than principal for the first several years of a loan. As the years progress, the monthly payments include more principal than interest. The sooner the principal is paid, the less overall interest is required, allowing owners to avoid that interest cost entirely.
Any amount of extra money toward the principal of a mortgage will reduce interest and shorten the life of the loan. Some homeowners choose to pay an additional $10 with each payment and others $200. As lump sums of money are earned through tax refunds, commission checks or other sources they can be applied as extra principal with the next mortgage payment. In most cases no schedule is needed for these payment increases.
Many homeowners enroll in bi-weekly payment programs to schedule additional payments on their mortgages. Bi-weekly programs are set up through the loan servicer or a third party to coordinate half mortgage payments every two weeks. They result in 26 half-payments each year, rather than 12 full payments. The bi-weekly program schedules in one additional full payment toward the principal each year, which dramatically reduces both interest paid and the total life of the loan.
Another way for homeowners to save money on their mortgages is to eliminate private mortgage insurance costs. Homeowners who pay less than 20 percent of the selling price of the home as their down payment are required to pay private mortgage insurance (PMI). This insurance protects the lender’s investment until the borrower has 20 percent equity in the home. Some loan terms require PMI to be paid upfront, where most PMI costs are rolled into the loan. Generally, the PMI is paid for a fixed period of time or until the balance of the principal reaches 80 percent.
Homeowners who pay less than 20 percent as a down payment should be aware of when PMI payments stop. When the balance of the loan is less than 80 percent of the home’s appraised value, then the owner should petition their lender to cancel the PMI. Owners commonly pay for an appraisal to cancel the PMI. The sooner the PMI is discontinued, the less total costs the homeowners will pay over the life of the loan.
Homeowners can save money on their mortgages by refinancing to get a lower interest rate. Because interest rates are near all-time lows, it’s an incredible savings opportunity for current homeowners with high rates to refinance. Lower interest rates decrease the cost of monthly payments and the total amount of interest paid over the life of the loan.
However, the cost of refinancing is high due to the numerous fees involved in the process. Before refinancing, consider the total cost of fees verses the monthly saving of the refinance. How long it will take to break even? If the homeowner plans to sell the home in six years, but it will take eight years to for the reduced monthly payments to balance out the cost of fees, then refinancing is not a savings option. Zillow provides calculators for users to evaluate their mortgage payment breakdowns and refinance savings.
Another savings option for homeowners is to recast their mortgages for smaller monthly payments. In order to recast, homeowners need a lump sum of money to apply toward their principal. Generally, a minimum sum of $5,000 is required by the loan servicer. When that bulk payment is applied to the principal it eliminates some interest costs. The loan servicers then recalculate the remaining costs of interest and principal over the existing length of the loan. Recasting a loan does not shorten the length of the loan, but it does reduce the cost of monthly payments, with some interest savings.
This is a good option for homeowners who receive inheritance, work bonuses or large tax refunds. Lowering monthly payments can make a significant difference for some homeowners’ finances. Compared to refinancing, the fees are extremely low to recast a mortgage.
Rent Vacant Rooms
One more strategy to save money on a mortgage is to rent out unused rooms for extra income. First, homeowners should visit their local city or town hall website to research whether renting is legal in their area. Renting regulations vary depending on location and zoning. If renting is a legal option for homeowners, then it can become a convenient method to make paying the mortgage more affordable. Collecting a few hundred dollars each month and applying it directly toward the mortgage payment will save the homeowner money. If the monthly mortgage payment is affordable, then homeowners can apply the renters’ checks toward their principal, reducing interest and the life of the loan.
Homeowners who decide to rent out rooms in their homes should be aware of a few basic guidelines. Prepare an official lease to have the renters sign prior to moving in. It should include payment deadlines as well as late fee requirements. The renters should have set move-in and move-out dates. In addition to documentation the owner should screen the potential tenants before signing a lease. Homeowners should be aware of Fair Housing Laws to avoid discrimination when advertising their properties. Lastly, be sure that the home insurance protects a rented home and property.
In conclusion, there are a few solutions to make a mortgage more affordable. If paying down the principal in advance is feasible, it is an effective method to save money on a mortgage. Otherwise, petitioning to cancel PMI, refinancing and recasting a mortgage can create savings opportunities. To lighten the burden of the monthly mortgage payment, homeowners with extra rooms can turn to renters to make up a few hundred dollars each month. Instead of getting overwhelmed by the long-term debt of a mortgage, use these options to cut extra costs and become a debt-free homeowner.