Episode 12: Ask Mary Beth: Am I Sitting on Too Much Cash and How Do I Know How Much Mortgage I Can Afford?
AM I SITTING ON TOO MUCH CASH?
HOW DO I REALLY KNOW HOW MUCH MORTGAGE I CAN AFFORD?
One of the fun parts of being a financial planner is getting to field and answer questions from clients and readers all around the country. In these Work Your Wealth episodes I’ll be taking time to address and answer questions I’ve come across from readers and clients throughout my career. Today I’m answering the above questions.
WHAT YOU’LL LEARN FROM THIS EPISODE:
What amount is just enough cash to have on hand.
Where to keep your cash savings accounts.
How to determine what to do with additional cash beyond your emergency fund.
Planning for short versus long-term goals.
The lifestyle factors to consider before locking in a mortgage payment for the next 15 – 30 years.
Decisions to make before shopping for a house.
The #1 thing you need to get organized prior to planning a home purchase.
Once you’ve locked in a mortgage, it’s easy to think the deal is done (and a lot of the time you want to forget about the piles upon piles of paperwork you’ve just gone through). You assume you’ll make your payments on time and enjoy your new home into your happily ever after future. Sounds easy, right?
That’s definitely an option, but not the best one for the long term. Depending upon when you purchased your home and your timeframe for staying in it, there are plenty of ways you can whittle away at your monthly payment, save on interest and generally decrease the total cost over the lifetime of your loan. We’re not talking pennies here – we’re talking thousands of dollars a year.
Here are some of the best ways to do that, with examples of just how much you and your family could save on your mortgage.
Switch to a Lower Rate
You can refinance and save on interest without switching to a 15-year term. A 25-year $200,000 mortgage at 4.5%, when refinanced to 20 years at 3.5% will result in $171,619.34 less interest. That’s a savings of $8,550 per year.
It’s best to refinance when interest rates are low and you have an excellent credit score – usually 750 or higher. If you’re in the process of rebuilding your credit, consider holding off for the time being and also be sure to factor in any fees involved with the refinance process and how long you anticipate staying in the home.
Get Rid of PMI
Private mortgage insurance (PMI) is what borrowers pay when they make a down payment that is less than 20% of the home’s cost. PMI protects the lender in case you fail to make your payments in full.
Most lenders charge between .5 and 1% of the loan for PMI each year. For example, PMI on a $300,000 loan would cost $3,000 a year or $250 a month.
If you’ve reached 20% or more in equity, you can get rid of PMI by refinancing or asking your lender to drop it. Not every loan provider drops PMI automatically once you reach that threshold, so you might have to remind them. Some won’t drop PMI at all, so you’ll have to refinance to get rid of it.
Make a Bigger Down Payment
The smaller down payment you make, the higher your monthly payments will be. For example, a $300,000 home with a 3.5% down payment, 30-year mortgage with 4.5% interest rate will have a $1,467 monthly payment. A 20% down payment on that same mortgage would save the borrower more than $250 a month or $3,000 a year (and over $40,000 in interest over the life of the loan).
It will take longer to cobble together a bigger down payment, but you could save thousands of dollars on interest if you wait. Obviously, this isn’t an option for those who’ve already signed on the dotted line, but anyone still in the process of locking in their mortgage should consider taking this route.
Refinance to a 15-Year Mortgage
As you may have guessed, a 15-year mortgage comes with a higher monthly payment than its 30-year counterpart, but (and this is a BIG but) it comes with substantially less interest. For example, a $250,000 mortgage with a 30-year term and a market-average 4.25% interest rate will have a monthly payment of $1,229.85. You’ll pay $192,745.98 in interest over 30 years.
A 15-year mortgage with a 3.625% interest rate will have a monthly payment of $1,802.59, but you’ll only pay $74,466.67 in interest. That’s 2.5 times less than the 30-year option.
Helllooo money saved!
Make an Extra Payment Each Year
Making an extra payment each year can decrease your mortgage term without the hassle of refinancing every time interest rates go down. The easiest way is to divide your monthly mortgage payment by 12 and add that amount every time you write a check.
For example, if you pay an extra $100 a month for a 30-year $200,000 mortgage at 4.5% interest, you’ll pay it off five years sooner and save $31,746 in interest.
With your focus on building your down payment fund and figuring out what your mortgage payment will be, it’s easy to overlook some of the smaller fees that come along with a home purchase. Here are eight and what they could cost you.
1. Home Inspection A home inspection helps protect you from purchasing a home that could be a lemon. So you don’t want to forgo it. Inspectors will look for signs of structural issues, mold, and leaks; assess the condition of the roof, gutters, water heater, heating and cooling system; and more. Inspections cost between $300 and $500, and whether or not you end up purchasing the property, you still need to pay this fee.
2. Appraisal Fee This appraisal report goes to your lender to assure it that the property is worth what you’re paying for it. This report worked in our favor a couple of years ago when our home came back appraised for $10,000 less than our bid; the sellers had to reduce their asking price in order to move forward. An appraisal can costs between a few hundred to several thousand dollars depending upon the complexity.
3. Application Fees Before ever approving you for a loan, the lender is going to run your credit report and charge you an application fee, often lumping the credit report fee in with the application fee. This can run $75 to $300. Be sure to ask for a breakdown of the application fees to understand all costs.
4. Title Services These fees cover a title search of the public records for the property you’re buying, notary fees for the person witnessing your signature on documents, government filing fees, and more. These can cost between $150 and $400, and it’s important to get a line item for each cost.
5. Lender’s Origination Fees Your lender will charge you this upfront free for making the mortgage loan. This includes processing the loan application, underwriting the loan (researching whether to approve you), and funding the loan. These fees are quoted as a percentage of the total loan you’re taking out and generally range between 0.5 to 1.5%.
6. Survey Costs This report ($150 to $400) confirms the property’s boundaries, outlining its major features and dimensions.
7. Private Mortgage Insurance (PMI) When you put down less than 20% on your new home, the lender requires that you purchase PMI, which is a policy that protects the lender from losing money if you end up in foreclosure. So PMI is a policy that you have to buy to protect the lender from you. PMI rates can vary from 0.3% to 1.5% of your original loan amount annually.
8. Tax Service Fee This is the cost (about $50) to ensure that all property tax payments are up to date and that the payments you make are appropriately credited to the right home.
Always ask questions when it comes to understanding the fees you’re paying. If possible, print out documents and go through them with a highlighter to indicate any areas you have concerns about. Discuss them with your lender or real estate agent and determine if you can negotiate any of them down.
Don’t be afraid to price shop to ensure you’re getting the best value. Just because you’re spending hundreds of thousands on a home doesn’t mean you should be comfortable throwing thousands of dollars at fees.
This post was written in partnership with The National Association of Realtors. I have been compensated, but the thoughts and ideas are my own. For additional home finance tips, check out HouseLogic.com
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