While owning your own home can be a lot better than renting an apartment, there are significant costs associated with a mortgage. Closing fees, exorbitant interest rates and an extended repayment period are some of the things with which mortgagees contend. Given the long-term financial commitment of a mortgage, it is imperative that you avail yourself of any opportunity to reduce the payment or balance. Fortunately, there are several options for doing just that.
♦ Refinancing
Refinancing a mortgage is a common way to save money once you can refinance to better interest terms. This strategy is a good option for those who experienced changes in their financial circumstances or credit score. Sometimes, the changes can be external – a drop in lending rates that the mortgagee wants to take advantage of, for example. There are costs associated with refinancing, including property revaluation, but the benefits of refinancing usually outweigh the costs when you can get a lower interest rate by at least two percentage points.
♦ Choose loan terms that favourably affect your mortgage balance and payment
Buyers can choose the terms of the mortgage, such as the repayment period and the upfront contribution (down payment). Choosing a shorter mortgage term can save you thousands of dollars on interest payments. For example, a mortgage for $150,000 at 6.5% over 30 years might be approximately $341,000. Over 25 years, the same mortgage is approximately $304,000 – savings of $37,000.
A larger down payment reduces the monthly payment obligation by reducing the mortgage balance upfront. The demerit of these money-saving strategies is that their high opportunity cost. If you have to pay more money upfront or in a shorter period, it reduces your investment options. It is necessary to achieve balance between the opportunity cost and the savings on interest.
♦ Extra payments and mortgage recasting
Making extra payments would reduce your loan balance and shorten your repayment period as well. However, an additional benefit of making extra payments is that some lenders might recast your mortgage if you make extra contributions that are sufficient enough to persuade the lender to offer you new terms. The recast mortgage does not necessarily yield a shorter repayment period, but a lower interest rate and monthly payment.
♦ Save on mortgage insurance
Mortgage insurance is a critical component of a mortgage, especially as it is mandatory for some lenders. Generally, private mortgage insurance has a higher rate than many term insurance plans offered by life insurers. Mortgagees have two options: reduce the cost of mortgage insurance by using a cheaper term alternative or negotiate the elimination of this cost with the lender when the mortgage balance is significantly reduced.
♦ Seller concession
The seller concession is a strategy that saves money in the short term although it increases the monthly interest payment and mortgage balance. The basic idea behind the concession is that it incorporates the closing costs in the cost of the house. Therefore, instead of struggling to pay upfront costs, these are spread out evenly in small monthly payments that are part of the loan repayment. This strategy is the opposite of making a down payment and it reduces the opportunity cost of the mortgage.
♦ Assume a mortgage
To assume a mortgage, it must be transferable and you must have the wherewithal to cover the difference between the purchase price of the house and the outstanding debt. Mortgage assumption means that you transfer the seller’s existing mortgage to your name. Where the prevailing interest rate is higher than the assumed mortgage, this strategy leads to significant cost savings.
The trick to truly saving on a mortgage is balancing the benefits and demerits of the money-saving strategies. For instance, making a huge down payment is not advisable if it means that you cannot save, invest and purchase protection products. Paying off a loan over a longer period means that you repay more, but it is inconceivable to pay off a mortgage in ten years because it saves more than a 30-year mortgage. Doing so means that you might forego many investment opportunities and it might be more of a financial handicap than a money-saver.