Understandably, when most home buyers look for a mortgage, their top priority is to get the lowest monthly payment. But it’s a better idea to look at how much it’s going to cost you over the long term, in both interest payments and fees. By looking at these costs, you can save a significant amount over the years.
Even if you already have a mortgage, there are still a number of strategies you can use to reduce the total amount of interest you’ll pay. Most of these accelerate the speed with which you repay the loan, and that reduces your long-term interest costs.
Here are some ways to reduce the long-term cost of your mortgage:
It always pays to get offers from several lenders when you’re shopping for a mortgage. Offers can vary substantially. Especially if your credit is considered sub-prime, you shouldn’t accept a high-interest rate mortgage without looking for a better offer. LendingTree, for example, has a network of over 250 lenders and can provide you with offers from up to four lenders in minutes.
One factor that increases the cost of your mortgage is the fees or points lenders add on to the deal. Look at these carefully, and don’t be reluctant to challenge fees that seem too high, or unreasonable costs such as unnecessary insurance. Compare offers using the annual percentage rate (APR), which includes both the interest rate and the fees. And if the lender gives you a “good faith estimate” outlining the extra charges, make sure these don’t increase markedly by the time the deal is closed.
Shorten the term
If you intend to be in the house for some time, you can lower your interest costs substantially by choosing a shorter mortgage term. This will increase your monthly payment but enable you to save significantly over the life of the loan. It may also enable you to get a reduced rate on the mortgage. For example, you can save $66,364 over the life of a $100,000 mortgage by choosing a 15-year term at 5.75 percent versus a 30-year term at 6 percent:
At 6 percent, amortized over 30 years:
Monthly payment = $599.55
Total interest over mortgage term = $115,838
At 5.75 percent, amortized over 15 years:
Monthly payment = $830.41
Total interest over mortgage term = $49,474
Assume a mortgage
One way to lower your long-term costs is to assume an existing mortgage from the seller of the home. This is worthwhile only if the existing mortgage carries a substantially lower interest rate than you could get otherwise. The mortgage must also be transferable, and the seller must be willing to arrange the transfer. However, if it’s feasible, you can save interest costs, and many of the usual settlement fees.
Pay down your mortgage
If you already have a mortgage, making extra payments to reduce the principal can reduce your total interest payments significantly, since the interest you pay depends on the amount you owe. It also shortens your amortization period, which also reduces the overall interest paid. Your mortgage must allow prepayment without large penalties, however.
If you can’t afford to prepay a lump sum, consider paying your mortgage every two weeks instead of monthly. The difference is hardly noticeable, but this can cut the amount of interest you pay since your principal decreases more steadily. And, since there are 26 two-week periods in the year, you actually make an extra monthly payment each year, further shrinking the principal.
Cut the PMI
If your down payment is less than 20 percent of the house price, you may be required to take out private mortgage insurance (PMI). However, once your mortgage principal decreases to 80 percent of the home’s value, you can petition your lender to cancel the insurance. This may happen after you’ve repaid some of the principal, or if the home’s value rises quickly. You may have to have the house reappraised, but the savings should make the expense worthwhile.
Since mortgage interest is usually tax-deductible, it pays to consider how it will affect your taxes before going ahead with a strategy to reduce your interest costs. If you are in a high tax bracket, it might not make financial sense. Consult a financial advisor for advice on your particular tax situation.