Do you want to save money on your mortgage?

Of course you do. Buying a home is the biggest financial investment most people make. You don’t want to throw your hard earned money down the drain. But what happens when you search the internet for advice? You find  dozens of articles that promise to tell you how to save money on your mortgage. What do they say?

They don’t tell you how to reduce your monthly payment

That’s right — and reducing your monthly payment is exactly what you want to do. If you do a simple search for “how to save money on my mortgage”, you’ll find article after article. But all of them say the same thing — make one extra payment.

Is that wrong? No — making one extra payment a year can payoff your loan faster, but it won’t reduce your monthly payment. It will reduce your overall interest bill, but you want to save money NOW, not 30 years from now.

Yes, 99% of the articles online focus on saving money AFTER you’ve closed on your loan. After you’ve signed all your closing documents and your rate is set in stone. They tell you to make one extra payment or pay your mortgage biweekly. All this does is reduce your overall interest bill — it doesn’t lower your monthly payment.  When you search “how to save money on my mortgage”, you want to know what you can do to make your monthly payment as low as humanly possible.

How do you make your monthly payment as low as humanly possible?

It’s so simple it’s crazy. Follow these five steps to ensure you close your loan at the lowest rate possible. These five steps can help you save thousands of dollars over the life of your loan.

Many people think shopping around for the lowest rate means they’re done. They can relax, confident they’ve done everything they can to get a loan at the lowest rate.

But finding a lender is just the beginning. After you shop around for the best possible rate, you have to do everything you can to close at that rate. Here are five tips to make your monthly mortgage payment as low as it can be:

  1. Understand how to lock in
  2. Make sure you close within your rate lock
  3. Consider if it makes sense to pay points
  4. Look at what you would save with an ARM
  5. Ask if a prepayment penalty lowers your rate

Understand How to Lock In

Let’s say you have done your research and chosen a lender who quoted you the lowest rate. You fill out the application form and submit your documents. Is your rate locked in?

Not necessarily. You need to ask your lender what you need to do to lock in your interest rate. Locking in means your rate is set for a specific period of time (usually 45 or 60 days).

Why would you lock in your rate? You would lock it in if you thought rates were going to go up. Conversely, if you thought rates were coming down, you would “float” your rate or not lock in.

What’s the best thing to do — lock or float? It depends. Rates fluctuate with the bond market, and when they increase, they can do so very quickly. A good rule of thumb is: if you like it, lock it. Don’t try to time the market perfectly. You only know a bottom after it has occurred.

Never assume your rate has been locked in until you get something in writing from your lender confirming the rate and lock in period. If you don’t lock in and rates go up a little as 1/8%, that could cost you thousands of dollars over the life of your loan.

Make Sure You Close Within Your Rate Lock

Once you lock in for 45 or 60 days, you want to make sure you actually close within that rate lock period. Why? Because if you go beyond the rate lock expiration date, you may have to pay fees to extend your rate.

How do you make sure you close within your rate lock period?

You have all your documents ready to go before you apply. Often borrowers take weeks gathering their W2s or bank statements. Make sure you know what underwriters will request and have it ready. Any reputable lender will be willing to sit down with you and go over your documents before you apply to make sure you have what you need.

Consider if it Makes Sense to Pay Points

Why would you pay points? To reduce your interest rate, which will help you save money on your mortgage. Points are simply the cost of reducing the interest rate. Each point is 1% of your loan amount.

How much does a point reduce your interest rate? With a fixed rate loan, one point typically reduces the interest rate by 1/4% or more. So when you shop around for your mortgage, you should ask for two quotes: one with 1 point, and one with zero points.

When is it worth it to pay points? To answer that question, you need to calculate a “break even” point. Here is an example:

You are buying a house and plan on borrowing $300,000. When you shop around, you get two quotes for a 30 year fixed: 3.75% with zero points, and 3.50% with 1 point. After calculating the principal and interest payments at each rate, you find you save $42 per month with the lower rate. However, it costs you one point or 1% of your loan amount to get that rate.

Does it make sense to pay the point? Calculate the break even point by dividing the cost of the one point ($3,000) by the monthly savings ($42). The break even point is 71 months, or almost 6 years. Therefore, if you plan on holding on to the mortgage for at least 6 years, you will save money by taking the rate with 1 point.

IMPORTANT TIP: If you are buying a primary residence, the points are typically deductible. So after taxes, that one point may cost you as little as $1,950, which means your break even is now just 46 months or under 4 years.

Look at What You Would Save with an ARM

When you shop for a mortgage, ask for rates on an ARM (adjustable rate mortgage). ARMs are typically fixed for a period of 5, 7 or 10 years, and the payments are amortized over 30 years. So for that initial fixed period, it’s just like having a 30 year fixed.

But you have interest rate risk when the loan starts to adjust. Is that risk worth it? It all depends on how much lower the rate is compared to a fixed.

Here is an example: you get a quote for a 30 year fixed at 3.75% with zero points. Your loan officer tells you he has a 7 Year ARM available at 3.25% with zero points. For your loan of $400,000, the difference in payments is $111 per month. Is that worth it to you?

Only you can answer that question. Your answer will be based on how long you plan on holding on to the mortgage and where you think rates will be in Year 8. Of course, if the ARM rate is even lower than 3.25%, it might make your decision easier.

Ask if a Prepayment Penalty Lowers Your Rate

This is the craziest one of all. No one in their right mind would ask for a prepayment penalty! What if you have to sell your house because you get relocated? With a prepayment penalty, you’re  automatically signing up for higher fees when you pay off your mortgage.

But think about it from a lender’s standpoint. If they can ensure that you won’t pay off your loan for a certain time period, they can potentially offer you a lower rate. Why? Because lenders want to guarantee receiving interest income on your loan. If there’s no prepayment penalty, you could pay the loan off at any time with no penalty. So the lender could theoretically only get the interest payments for a few months before you pay it off.

But if a lender imposes a prepayment penalty of a year, they are basically locking in receipt of your interest payments for twelve months. Which means they can offer you a lower interest rate on your mortgage because they’re guaranteed of getting those payments for at least a year.

How much lower is your rate with a prepayment penalty? It depends on the lender, but you could save 1/8% or more on your interest rate.

What does a typical prepayment penalty cost you when you pay off your loan? The most common penalty allows you to prepay up to 20% of your loan’s original balance without penalty, but if you pay off more than that, you incur a penalty of 6 months interest.

Is it worth it to you to risk incurring this penalty in order to save 1/8% or more on your mortgage? Only you can answer that question.

The bottom line is: ask for the information. Do your financial analysis, and make an informed choice. You owe it to yourself to explore all available options to save money on your mortgage before you close.

And that’s not crazy. It’s common sense.

Call Amerifund at (888) 650-7316 to find out how we can help you save money on your mortgage. Or fill out this form and someone will contact you.

(c) Copyright Eris Saari 2016, 2019