Refinancing has gotten a lot of attention in these times of lower interest rates. However, there may be a better way for you to save money on your mortgage. Recasting your mortgage loan, opting for a 15-year mortgage instead of 30-year mortgage, or making extra mortgage payments might be more beneficial. Read on to consider these options.
1. Consider a 15-year mortgage instead of a 30-year mortgage.
Put simply, when you opt for a 15-year mortgage, you will have a higher monthly mortgage. However, since you’re paying off your loan faster, you save more money on interest over the long term, and have the freedom of many months, and potentially years, without a mortgage at all.
This option has been gaining popularity. Recently, 30% of homeowners have selected a 15-year mortgage, accordingly to The Motley Fool.
The Motley Fool provides this example to help calculate how much you could possible save by choosing a 15-year mortgage:
“You're looking to take out a $200,000 fixed-rate mortgage, and you're approved for 4% interest for both a 15-year and 30-year mortgage … If you go with the 30-year mortgage, you'll wind up paying $955 a month and a total of $143,700 in interest over the life of the loan. If you take the 15-year mortgage, your monthly payment will be higher at $1,479, but over the life of your loan, you'll only wind up paying about $66,300 in interest. In all, you'd save over $77,000 by going with the 15-year mortgage.”
This option may be particularly beneficial in these scenarios:
· You have a stable job, are a salaried employee, and/or can afford the higher payment of a 15-year mortgage.
· You’re buying a home later in life and want to be debt-free in retirement. For example, if you’re buying a home, or a second home, at the age of 60 and you want that home to be paid off by the time you retire at 75.
· If you’re “early on” in a 30-year mortgage, and want to switch to a 15-year mortgage. Remember, banks amortize, and they don’t want to wait to get their money. So in the beginning of a mortgage loan, most of the monthly payment goes to the total amount of interest the bank will make over 30 years. If you’re one year into your mortgage, because of amortization, most of your mortgage payment has gone to interest, not principal. But, let’s say you receive a large raise in that year, realize you can afford higher monthly payments, and want to switch to a 15-year mortgage. This would be beneficial because you’ll save on interest over the long-term, and you will have your home paid off in roughly half the time. However, it’s worth noting, refinancing can cost thousands of dollars. On the other hand, if you’re “later on” in your 30-year mortgage, it might not make sense to switch to a 15-year mortgage because you’ve already paid the bank most of their money in interest, you could end up extending the length of your loan, and pay the bank even more in interest. For example, if you’re 20 years into your mortgage, and you switch to a 15-year mortgage, even though your monthly mortgage payment would come down, because you’ve just added five years to your payoff, the amortization resets, so most of your monthly mortgage payment would go to the bank in interest at the start of that 15-year loan.
The Motley Fool reminds us, “While a 15-year mortgage will result in a higher monthly payment than a 30-year loan, it won't double your payment.” Use this mortgage term and rate calculator to find out if this option is worth considering.
2. Make extra payments monthly or one large payment per year.
You might want to consider making extra mortgage payments if you want to have your loan paid off sooner and want to save on interest over the long term.
However, it’s important to be strategic and clear about how extra payments are applied to your mortgage, according to The Mortgage Report. Communicate to the bank that these extra payments are for the principal of the loan, not the full loan. Otherwise, the bank could apply it to the next month’s interest. In many cases, you can do this electronically by checking a box that says, “apply toward principal”. Or, if you’re writing a check, write in the memo that the funds are to be applied to the principal.
Considering a 15-year mortgage could save you thousands in interest. “A 30-year fixed-rate mortgage at 4% and $200,000 borrowed would require about $140,000 in interest over the life of the loan. But if you were to prepay just an additional $100 a month toward principal, you would save about $30,000 in interest , and pay off that loan five years quicker,” points out The Mortgage Reports.
For many, paying your mortgage loan biweekly is considered to be beneficial. However, as Clark.com debunked, paying biweekly doesn’t make as much sense as it seems.
Most people think when they pay biweekly, the mortgage company uses part of that early payment toward interest and part of it toward principal. However, according to Clark.com, when you make biweekly payments, the mortgage company usually holds on to that money for two weeks until they see that you’ve paid the full monthly payment.
There are some mortgage companies that do allow for biweekly payments, but they usually charge an extra fee, which could defeat the purpose.
There’s one upside to making biweekly payments, and that’s the extra payment toward your mortgage that results from paying every two weeks.
“While many people think of a month as being four weeks, and half a month being two weeks, that isn’t quite true. Because there are 52 weeks in a year, there are 26 biweekly periods. So if you make 26 half payments, that is the same as making 13 regular monthly payments, or 1 extra payment per year,” according to Clark.com.
Clark.com provides this example as to how beneficial it can be to pay an extra mortgage payment per year: Say you have a 30-year $160,000 mortgage, and make an extra payment once a year. Therefore, you end up paying your mortgage off in 26 years. Paying your mortgage off four years early will reduce your total interest payments by roughly $14,000.
So, if the biggest advantage to paying biweekly is the extra mortgage payment per year, then consider doing so by following these steps:
- Create a savings account.
- Determine how much you need to put in the savings account every month by dividing your monthly mortgage payment by 12.
- Each month deposit that amount of money into your savings account.
- After 12 months, take what you’ve saved, and make an extra payment.
Plus, if you put your savings in a high-yield interest account, you’ll gain interest on your savings, which as Clark.com points out is, “ better than letting your mortgage company hold onto your money for 2 weeks interest free.”
3. Recast your mortgage loan.
When you “recast” your mortgage, you pay a lump sum toward the principal of your loan to reduce your principal balance, which reduces your monthly principal and interest payment. Your monthly payment is then reset, or re-amortized, based on the new, lower amount due – and according to your original interest rate and loan terms.
We interviewed Chris Starks, a Senior Loan Officer at First Class Financial Services, to help explain this option.
Starks offers this scenario to help explain how recasting your mortgage could be beneficial: “Let’s say someone has a principal balance of $361,790 with 25 years left on the loan, and their current interest rate on their 30-year fixed mortgage is 4%. If they put $50,000 towards the principal balance and recast the loan, they now have a balance of $311,790. Their rate is still 4%, and they still have 25 years left on the loan, but their new monthly payment has decreased by $264 each month over 25 years, which means their savings is $79,200 over those years. With a savings of $79,200, less the $50,000 they applied towards the principal balance, their ultimate savings over those 20 years is $29,200.”
According to Chris, there are many benefits to recasting. It’s low cost, and there’s no credit check or income verification required. Lenders typically charge around $200 for the service, but since it’s not considered a new loan, there are no closing costs.
In comparison, to refinance a loan, it’s usually necessary to pay lending feeds around $650-$850, appraisal fees around $300-$400, credit fees around $25-$65, insurance fees, taxes, escrow fees, title fees, and points (discount fees or origination fees) with one point equating to 1% of the mortgage amount. These costs all vary depending on the loan amount, interest rate, credit score, and lender.
After reviewing all of those fees, recasting your loan for $200 might sound pretty good.
According to Chris, this would be a good option for:
1. Homeowners with bad credit
“Because there’s no credit check for a recast, an individual with less than perfect credit can take advantage of this, where a refinance may not be available to them because of their credit score.”
2. Self-employed homeowners
“Homeowners who have recently moved to self-employment can recast their loan. If they wanted to refinance their loan, in many cases, the underwriter may require that they be self-employed for at least two years before approving a refinance.”
3. Homeowners who come into a windfall
“Homeowners who recently received a large sum of money through an inheritance, bonus at work, gift, etc. will oftentimes recast their loan if they feel like there’s a bigger benefit in doing that versus investing the money.”
4. Homeowners who are buying a new home before they sell their current home
“In this competitive real estate market, if a buyer can put in an offer on a house without having a contingency in their offer that their current home must be sold first, then that’s a much stronger offer, especially in a multiple offer situation.”
Some mortgage loans are typically ineligible, such as FHA, VA, USDA, interest-only, adjustable rate, or jumbo loans.
Starks says many people don’t know about recasting because investors aren’t advertising it to their clients, so if you’re considering recasting, and think you’d be a good candidate, be proactive about asking lenders about it.
As with all of these options, it’s worth asking a financial professional to run the numbers to find out whether a more traditional refinancing option is better or worse, or if a different investment opportunity could offer a higher return.
Have you tried one of these money-saving mortgage ideas? Help others save by sharing your personal experience on Transamerica’s Wealth+Health Community.
Neither Transamerica nor its agents or representatives may provide tax, investment or legal advice. Anyone to whom this material is promoted, marketed, or recommended should consult with and rely on their own independent tax and legal advisors and financial professional regarding their particular situation and the concepts presented herein.
Things to Consider:
- If you can afford it, you may benefit from opting for a 15-year mortgage.
- If you have a large sum, educate yourself around how recasting your mortgage could be a good option.
- Understand why it might be better to make extra payments towards your principal rather than biweekly payments.
- Talk to your financial professional to find out which way to save money on your mortgage could best suit you.