Taking control of your mortgage debt

I remember my first mortgage. Getting it seemed like a bureaucratic hurdle on the way toward buying a home, and I couldn't wait to get the paperwork done and out of the way. By the time we bought our second house, I was 10 years older and wiser. I played a much more active role in choosing a mortgage and negotiating terms that time, and saved us a fair amount of money as a result.

Assuming most people are about as naive as I was when they obtain their first mortgage, I want to offer some tips on how to be less passive so you can actively take control of your mortgage situation. My first time, I didn't think of it as a process that starts before you even apply for a mortgage, continues on as you choose a home loan, and even carries through once you are in your house and making payments on your loan — but it's very helpful if you do.

Before you shop for a mortgage

Let's say you're talking about buying a house but haven't even started shopping around. Is this too early to start thinking of a mortgage? Not at all. Here are some things to do early on that could save you some money once it comes time to get your home loan:

    1. Take time to save up for a larger down payment. There are a few benefits to boosting your savings account. Obviously, by allowing you to borrow less, this will both reduce the size of your monthly payment and the amount of interest you pay in the long run. It could also qualify you for a lower mortgage rate, and/or a loan with cheaper or no mortgage insurance necessary.
      A larger down payment will also start you out with an equity cushion, which will give you more flexibility to refinance once you own a house.
      Finally, going through the process of saving a regular amount every month will help you test the budget discipline you will need when you start making mortgage payments.
  1. Safeguard your credit rating. It's little use to start worrying about this once you are ready to apply for a loan. Building a good credit history needs to start long before then. Doing so could help you qualify for a lower interest rate, or even make the difference whether or not you are approved for a mortgage.
  2. Target a reasonable price range. Don't fall in love with a house and let it determine your budget. Before you start house hunting, use a mortgage calculator to figure out what you can afford. Allow some room for the unexpected expenses that are an inevitable part of home ownership, and also leave yourself some leeway to ride out a financial setback now and then. Limit your house search to the price range you figure out, and you will avoid being tempted into something you can't afford.

While you are looking for a mortgage

Okay, now that you're ready to buy a home, here are some things to remember as you look for a mortgage:

  1. Shop actively for a lender. Even small rate differences add up to big bucks when you apply them to the cost of a house and project them out over 30 years.
  2. Look at local real estate market dynamics. Even if you fall madly in love with the first house you see, check out other properties to see if the price of the one you picked is in line. Also look at local market dynamics like how many properties are for sale nearby and how long properties are staying on the market before they are sold. This will tell you whether it's a buyer's market where you can try to drive a hard bargain or a seller's market where you had better jump to meet the asking price as soon as possible.
  3. Consider alternatives to the standard 30-year, fixed-rate mortgage. This type of loan suits most first-time home buyers because it offers stable payments that are made more affordable by stretching them out over 30 years. However, make sure you understand the pros and cons of alternatives, and how they might apply to your situation.
    For example, a 15-year mortgage is likely to offer a lower interest rate — as of the end of 2015, 15-year mortgage rates were 0.77 percent lower than 30-year rates. It will also cost you much less in the long run because you will be paying interest for half the number of years. The drawback is that 15-year loans have higher monthly payments, which you may not be able to afford.
    As for adjustable-rate mortgages, these offer even lower initial rates, but carry the risk that your interest rate — and thus your monthly payment — can vary. However, buyers who are planning to move in a few years or otherwise expect to be able to pay the loan off early may be less exposed to this risk.
  4. Be aware of prepayment penalties. Many mortgages have these terms, so be aware that they could make it more expensive to refinance later on.

Once you have a mortgage

Now you have your mortgage, the only thing you need to do to control this debt is to make your monthly payments, right? Well, also consider the following:

  1. Be cautious about home equity loans. These can be a tempting source of cash, but eroding your equity can limit your ability to refinance. It could also leave you still paying off your mortgage into your retirement years.
  2. Be alert for opportunities to refinance. The best kind of opportunity is if interest rates fall, but you might also benefit from restructuring your mortgage. For example, if you can afford higher payments, shortening your mortgage term should reduce your long-term interest expense. Also, if you initially chose an adjustable-rate mortgage, you may decide it would be beneficial to stabilize your monthly payments by switching to a fixed-rate loan.
  3. Understand the cost of lengthening your remaining mortgage term. Refinancing to a fresh 30-year mortgage can be an easy way to make monthly payments more affordable, but it is likely to raise your interest expense over the life of the loan. Use a mortgage calculator to figure out the long-term cost of reducing your monthly payments this way.

People tend to feel that their debt controls them rather than the other way around. Probably the biggest difference between when we bought our first home and when we bought our second was learning to take more control of financial decisions rather than sort of being swept along by them. Taking control of your mortgage debt should not only help you build wealth, but also make you feel more secure in your home.

Have you taken measures to control how much mortgage debt you have? What steps did you take? What do you recommend?

More about...Debt, Home & Garden

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Karthigan Srinivasan @ StretchADime
Karthigan Srinivasan @ StretchADime

Excellent post. The average time American families live in a home is about 6 to 7 years. If you belong to this bucket, then you are better off going with a 5 year or 7 year adjustable-rate-mortgage (ARM). You get a lower interest rate as the author has indicated. I lived in my old home for about 9 years and had signed up for a 30 year fixed rate. Career / Life took me to another state and a greener pasture. So I had to sell and relocate. I would have saved more on interest had I gone with an… Read more »

uri
uri

there are good arguments for approaching things differently. put the minimum amount of money down (usually 5%, but can be less with government-insured mortgages) to get the most leverage and to buy quickly (interest rates look like they are about to rise). get a 30-year mortgage. you pay less interest on a shorter mortgage, but the tradeoff is that you pay the whole thing in earlier, less inflation-devalued dollars. the higher monthly payments can put stress on your budget. if you really want to pay it off in 15 years, reduce your chances of default by getting a 30-year mortgage,… Read more »

Jo-Pete
Jo-Pete

“paying the regular monthly amount and setting aside the difference between a 15-year and 30-year payment. then on year 15, make a lump sum payment using the set-aside money. just make sure the mortgage doesn’t have a prepayment penalty” You’re not taking compounding interest into account. Let’s assume a 100k mortgage at 5%. Also assume you’re getting a 1% APY on your savings. If you use your approach, you’ll get to year 15 with $49,306 in savings and $67,844 on your mortgage. If you have a magic savings account that gives a guaranteed 5% APY, it would be a wash.… Read more »

C Sturgis
C Sturgis

Biggest thing is to not bite off more than you can chew. The banks will approve you for a loan that is much higher than you want to be paying for monthly. Really take some time to find the sweet spot for your monthly payment and reverse calculate from there, but don’t forget about taxes and insurance while doing mortgage calculations. If you want to live near a certain city but are somewhat flexible on location, there are often outlying areas with much lower priced housing than living in that city. It might mean a 30 minute drive to go… Read more »

Another Beth
Another Beth

I think this article was informative, but could GRS write an article about the other side of the coin – what do you do when you’re ready to pay it off (besides jump for joy that you’ve paid it off)? A step-by-step guide would be so helpful.

PawPrint
PawPrint

I would love an article like this, too.

lmoot
lmoot

I think with mortgages it’s definitely a case of “one size does not fit all”. As tempted as I often am to say “20% down is the best”, I have heard of some cases when it’s not. Typically when the market is depressed, and/or interest rates or low, or there’s a great deal to be had, the house will be paid off early, DTI is low enough to easily afford higher monthly payments, income property…or any other scenario in which the benefits outweigh the cost of a lower DP. Personally I put 20% down on my house because I didn’t… Read more »

Victor Reiner
Victor Reiner

Even if your life situation changes it might make sense to keep a home you bought and rent it out rather than sell. This may affect your choice of loan to shop for. I believe the expense of selling real estate is very high (commissions etc.) and is ultimately not worth it if it can be avoided. For example, I am refinancing from a 30-year to a 15-year with the plan to pay the entire mortgage. Even if my situation changes and I decide to move, I’ve already determined that the house and neighborhood are a good long-term investment.

lmoot
lmoot

I agree. It seems that folks used to hold property and now it’s common to simply trade instead of acquire. Say what you will about the stability of real estate, there’s a reason why many wealthy people own multiple properties, which they lease out. I understand that dealing with being a landlord, or dealing with a management company is unappealing to many, but it’s strange that so many don’t even try. I also suspect that for many it’s easier and more attractive to not have to save money for another downpayment. That, unfortunately, is probably the driving factor behind trading… Read more »

T.C. Strait
T.C. Strait

One important thing that I believe was left out is who you choose to work with (loan officer, realtor, etc.). Unfortunately, just like any other industry, there are bad apples out there, that can really turn a first time homebuyer off from purchasing a home. Either the loan officer isn’t willing to put in the time to answer your questions (and first time homebuyers have A LOT) or aren’t willing to help you months in advance to make sure things are in line. I’ve dealt with many clients that came to me after speaking with other banks/loan officers, and the… Read more »

Frank
Frank

I mostly agree with URI For the most flexibility at reasonable cost. Get a 30 year. Then you can make payments at the 15yr schedule or set aside the difference and pay it off later (though probably closer to year 17 than 15 as he suggests). Payments are low, money is liquid and you only pay a little more in interest for the “insurance.” I would generally discourage people from any sort of ARM. There is one big exception tough. I work with a few people that are at the end of their well-paid careers and have plenty of liquid… Read more »

CalLadyQED
CalLadyQED

I wonder if banks take age into account when they determine a potential borrower’s risk class. If a 55-year-old seeks to refi to a new 30 year mortgage, does the high probability that he’ll only be working for another 5-10 years significantly alter his risk profile from that of a 40-year-old with an otherwise identical credit history?

lmoot
lmoot

Banks take assets into consideration as well. Though they may have less working years ahead, it’s likely they’ll have more assets than someone half their age. Assets are probably even seen more favorably as employment is less stable.

Tom
Tom

Very interesting advice, I had never considered that something other than a 30 year loan would result in a lower rate. I will defiantly keep that in mind when looking around this year. (I just hope it is at least somewhat similar in Australia!)

Jason
Jason

I think the biggest piece is to figure out a mortgage that you can pay off in a reasonable time (e.g. 15 years). If you can’t then maybe you don’t need to go up in house. Bigger isn’t necessarily better.

Financial Samurai
Financial Samurai

I think too many people buy too much home. It is much better to live within your means than take out a massive mortgage and be stressed all the time.

I paid off my first property’s mortgage in 2015 after 12 years and it feels priceless.

Live w/in your means folks!

Sam

Sara
Sara

I had to refinance my house last year (got divorced, part of the agreement was that I need to refinance the mortgage into my own name). This is my first house, however I had refinanced twice went rates went down, so I’m not new to getting a mortgage. What was different this time, was that I needed the bank to take into account child support as part of my income to qualify for the loan. I knew I could handle the payments since I had been paying it on my own for almost a year, but in order to fit… Read more »

James
James

Can’t agree more with the advice here. To add to it do your due diligence and shop for mortgage refinance. Calculate all the numbers upfront to choose the best option. Usually refinancing with a mortgage rate lesser than 1% of your current rate is the best option. It will save you some money. For refinance go to a bank and a loan aggregator simultaneously and then cross share their GFEs. Best luck!

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