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 discount points. 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 rate sheet, 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.

Down Payment

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 reduced.
  
  
• 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 mortgage calculator, 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.

Prepayments

A prepayment 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 benefit.

You can use this site's mortgage calculator 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

Refinancing refers to paying off an existing loan with the proceeds from a new loan, using the same property as collateral.

Refinancing offers many potential benefits - lowering lifetime interest expense, reducing the monthly mortgage, paying off the mortgage sooner, etc. 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 refinancing. The mortgage calculator makes it easy to assess refinancing costs and benefits. This type of analysis is illustrated in the refinancing case study.

Prepayment Penalty

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 penalties.

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 mortgage calculator 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 mortgage 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.