How to Cut Mortgage Costs
This lesson describes ways that home buyers can control mortgage
costs and save thousands of dollars over the life of their loan.
Interest Expense and Points
With most home loans, the biggest mortgage expense is
interest expense. One of the best ways to control interest
expense is through the wise use of
With discount points, you pay a fee at closing to lower your
interest rate, which also lowers your interest expense.
Most lenders offer many different rate/fee options; you can pay more
at closing and lower the interest rate a lot,
or you can pay less and lower
the interest rate a little bit. If you ask for their current
most lenders will provide a complete list of rate/fee options.
All you have to do is to evaluate each of the rate/fee options and
choose the option that minimizes your total mortgage cost
during the time that you live in your home. This analysis
is not hard. To see how it is done, review the
discount points case study.
Your down payment affects mortgage costs in two important ways.
- Loan amount. A larger down payment means
a smaller loan amount (i.e., you borrow less money). Since the
loan amount is smaller, the interest expense is
- PMI expense. Most lenders will require you
to pay for
private mortgage insurance (PMI) until the loan balance is
less than 80% of the home's fair market value. Increasing the
down payment hastens the day when the loan balance falls below the
80% mark, which reduces the PMI expense.
Here's the rub: A larger down payment means savings over the life of
the loan, but it also means more money out of your pocket at closing.
To determine whether a larger down payment is justified, you need
to compute the savings it produces. Using the Mortgage Mavin
this analysis is easy. To see how it is done, review the
down payment case study.
Type of Mortgage
The next three lessons describe different types of mortgages in some
detail, so we will not discuss the relative merits of different types
of mortgages here.
However, it is important to note that the type of mortgage you select
will affect mortgage cost, often in unexpected ways. The best way to
determine which type of mortgage is right for you is to estimate the
total mortgage cost of each option, and choose the low-cost alternative.
You can see examples that illustrate this type of analysis in the
total cost case study and in the
find the best mortgage case study.
is an excess payment on a mortgage loan. A prepayment will
reduce loan duration and total interest expense. You can prepay any
amount and receive benefit; the more you prepay, the greater the
You can use this site's
to determine exactly
how much the loan duration and interest expense will be reduced from
any prepayment strategy. To see how, review the
prepayment case study.
Refinancing refers to paying off an existing loan
with the proceeds from a new loan, using the same property as
Refinancing offers many potential benefits - lowering lifetime interest
expense, reducing the monthly mortgage, paying off the mortgage
Given the benefits, why not refinance? Sadly, refinancing
is not free. Settlement costs can amount to thousands of dollars.
In order to decide whether to refinance, the benefits
of refinancing must be weighed against the costs of
makes it easy to assess refinancing costs and benefits. This type
of analysis is illustrated in the
refinancing case study.
As a home buyer, you may have a choice - whether
or not to accept a
prepayment penalty clause in your mortgage contract.
Before making a decision, consider the following.
- Normally, prepayment penalties are only charged if you
sell or refinance in the first
few years of your mortgage. We will call this the
prepayment penalty period.
- Loans with prepayment penalties
usually have lower interest rates than loans without prepayment
Therefore, if you do not intend to sell or refinance
during the prepayment penalty period, you
should accept the prepayment penalty clause in
order to get a lower interest rate. If you do plan to sell or refinance
during the penalty period, use the
to weigh the cost of the prepayment penalty against the benefit of a
lower interest rate. This type
of analysis is illustrated in the
prepayment penalty case study.
Miscellaneous Settlement Costs
At closing, home buyers incur numerous miscellaneous expenses (legal fees,
document fees, recording fees, etc.). Compared to interest expense,
these fees generally represent only a small part of the total
||Some lenders use low settlement fees as
a marketing tool, hoping you will not notice that their interest
rate and total mortgage cost are high. Your focus
should be on the total package - not on individual
fees. Be willing to pay higher settlement fees to get a mortgage
with the lowest total cost.
Even though their role is usually small, you should
not ignore settlement fees. Occasionally, you run across lenders
that overcharge egregiously, turning an otherwise good offer into a
bad offer. Or if your two best lenders offer otherwise comparable
deals, the settlement fees may determine which
alternative has the lowest total cost.