This week I want to focus on debt. Why? Many people have debts, but few have a debt strategy. If you’re going to focus on your craft, you should minimize distractions with confusing terms and high repayment options.
The biggest debt for most people is their mortgage, so we’ll start there.
Here’s some good news: mortgages don’t have to be ominous, and if you do them wisely, you can come out ahead on your mortgage decision.
Let’s start with what a typical mortgage looks like and then we’ll talk about money-saving strategies.
Ideas You’ll Need to Understand About Mortgages
Most mortgages are repaid over either 15 or 30 years. While other terms exist, stick with these two. Here’s why: Most banks compete in the 15 and 30 year arenas, so you’re much more likely to find a competitive rate. That’s not the case with other options, like a 10 year or even 40 year loan. (side note: Who wants a mortgage 40 years from now? Not me…..)
There are (generally) two types of interest rates on a mortgage: fixed or adjustable rate loans. Fixed rate loans guarantee that you’ll keep the same rate for the whole term of the loan. These types of loans are attractive when rates are low. When rates rise, some people opt for adjustable rate loans. These loans will move as interest rates rise and fall.
Before you sign on an adjustable rate loan, ask your lender a few questions:
- How often will the loan adjust?
- What is the maximum percentage a note can rise or fall? (most loans cap the amount they can change in a year. Knowing the “worst case scenario” can help you budget for the future.)
A popular offshoot of an adjustable rate loan is called a balloon loan. These generally keep a fixed rate for a short period, but at the end of that term you’re forced to make a huge “balloon payment” or refinance. (One example of a balloon loan is a 7 year balloon. That means you have a fixed rate for seven years but then the loan ends).
Some questions to ask about a balloon loan:
- Is the rate fixed or adjustable before the balloon is due?
- What’s the penalty if I don’t find other financing at the end of the balloon? (You want to be clear about the fact that you’ll probably lose the house.)
- How long do I have until the balloon payment?
Here’s where most people get “in the weeds” with mortgage planning. Mortgages can be riddled with additional fees.
Like anything else, it’s easier if we just stick to the basics. Here are few fees to watch out for:
Appraisal fee – In the area where I live appraisals cost around $350. However, I’ve been told these vary widely depending on where you are.
Title search – Your mortgage company has to make sure you don’t have any liens filed against the title. These costs vary widely.
Application fee – This covers the cost of processing your application and checking your credit.
Origination fee – If you work with a broker, this represents their commission.
Mortgage Underwriting fee – Here’s the “garbage can” of fees that are added to a mortgage.
How to Lower Your Interest Rate
Pay Points – To keep it simple, points are upfront fees you pay to lower the interest rate on the loan. Ask your lender how much points will cost for your mortgage and how that’ll lower your interest rate and payment.
How to Lower Your Closing Costs
There are two options and people often get them confused:
Costs rolled into the loan – I’ve met tons of people who think they’re getting a loan without closing costs….which ends up not being true. They’re often actually getting a loan where the mortgage team has raised the amount you’re borrowing to include the loan costs.
No closing cost mortgage – Often this is my favorite type of loan. You’ll pay no fees for the loan but your interest rate will probably be a little higher (the company needs to make money somehow….you just decide how you want them to take their fee….in this case you’re telling them to have more interest instead of paying for it elsewhere). Why do I like them so much? No cost loans make my decision-making easier in the future. I don’t have to worry about how much money I’ve sunk into the existing loan before deciding to refinance later.
Note: Sometimes people think they’re getting taken advantage of by their mortgage company because they were sold a “no closing cost” loan but ended up with a higher loan amount. If that’s your situation, you might not be getting taken advantage of. Here’s the thing: because you skip a month’s worth of payments when you refinance, your loan amount actually goes up by the amount you didn’t pay. In effect, you’re rolling in the month you didn’t pay….but not closing costs.
Two easy strategies that get a little “creative” (perfect for our audience!):
1) Take a longer term loan and save the difference elsewhere. I’m a big fan of keeping my money flexible, but I also want to pay my loan early. I detest 15 year loans unless there’s a huge difference in the rate between the 15 and the 30. With a 30 I can pay my loan along the 15 year timeline but back down the payment schedule if I have a financial meltdown, such as if I lose my job or get disabled. Some people like to save the extra money into the loan. I prefer saving it into an S&P 500 mutual fund.
2) Make extra payments during the year by changing your payment schedule. Here’s a plan: make an additional payment two weeks early and then continually pay more every two weeks. If your bank will put those payments on your loan as they come in, this will reduce interest by a ton. If not, you might be wasting your time. Check with your bank to see how they’ll handle you paying early (you may just have to make one extra payment a year).
Mortgages don’t have to be an ugly beast. Hopefully this information will help you to complete the mortgage process painlessly and spend more time on your craft!