Paying More Today Won’t Lower Future Monthly Mortgage Payments

Posted on February 24th, 2021

Just about everyone with a home loan ponders the idea of paying a little extra, whether it’s via biweekly mortgage payments, or just once a year after receiving a sizable bonus or tax refund.

Whatever the method, you should first consider why you’re thinking about paying your mortgage off early as opposed to putting the money elsewhere.

This is a particularly important question to ask in the super-low mortgage rate environment we’ve been enjoying for some time.

Simply put, mortgage borrowing is really cheap, and probably the least expensive debt you’ve got, so prioritizing it over other debt may not make sense.

For example, if you have student loan or credit card debt, it might be more beneficial to pay that off first.

Anyway, assuming you do decide to make extra mortgage payments, whether significantly larger or just a little more than required, your next monthly payment won’t be affected by the previous payment.

You will still owe what you owed the month before, regardless of your principal balance being smaller.

While this might sound unfair, it all has to do with math and the fact that a mortgage is an amortizing loan.

A Mortgage Is an Amortizing Loan with Equal Monthly Payments

  • Most mortgages have a set loan term in which they are paid off in full
  • Fully-amortizing payments consist of a principal and interest portion
  • The monthly payment amount typically doesn’t change unless it’s an ARM
  • But the portion that goes to principal/interest will adjust over time as your loan is paid off

Traditional mortgages are paid off over a certain set time period with regular monthly payments that consist of a principal and interest portion.

This total payment amount does not change (barring an ARM adjustment or negative amortization) regardless of whether you pay more than is due each month.

The only thing that changes over time is the composition of your mortgage payment, with the portion going toward principal increasing over time as the loan balance falls.

As more goes toward principal, less go toward interest – picture an old-fashioned balance scale where one side drops while the other rises.

Let’s take a look at an example to illustrate:

Mortgage amount: $100,000
Mortgage interest rate: 5%
Loan type: 30-year fixed
Monthly payment: $536.82

In this example, your monthly mortgage payment would be $536.82 per month for 360 months.

The very first payment would allocate $416.67 toward interest and the remaining $120.15 would go toward principal.

This right here illustrates how interest on mortgages is front-loaded, with about 78% of the payment going toward interest and doing nothing to pay down the loan balance.

To calculate the interest portion, simply multiply 5% by $100,000, and divide it by 12 (months). The principal portion is the remainder, as noted above.

For the second payment, you need to use an outstanding balance of $99,879.85 to account for the principal amount paid off via payment one.

So to calculate interest for the second payment, you multiply $99,879.85 by 5% and come up with $416.17. This is the interest due and the remainder of the $536.82 payment goes toward principal.

Over time, the interest portion decreases as the outstanding balance decreases, and the amount that goes toward principal increases.

Pay More Each Month and the Payment Composition Will Change

payment composition

  • While paying more than necessary won’t lower the minimum amount due on your next mortgage payment
  • It will change the composition of all future payments thanks to a lower outstanding balance
  • This means you’ll save on interest and reduce your loan term despite owing the same each month
  • In other words paying extra is well-suited for those looking to save money long-term, not to obtain payment relief

If you make some additional payments, the outstanding loan balance will drop prematurely based on the original amortization schedule.

But instead of your monthly mortgage payments decreasing, the composition of your next payment (and the payment after that) becomes more principal-heavy.

In other words, the payment due would still be $536.82 the next month, but more of it would go toward principal (paying down your balance).

And for that reason, less interest would be paid throughout the life of the loan, and the mortgage would be paid off ahead of schedule. These are the two benefits of making larger payments.

The obvious downside is you wouldn’t enjoy lower payments in the future, which could be an issue if money becomes unexpectedly tight, especially seeing that you used it to pay your mortgage down quicker.

Instead, more money is essentially locked up in your home until you either sell the property or refinance and pull equity (cash out refinance).

Recast or Refinance If You Want to Lower Future Payments

  • As noted extra payments alone won’t lower future ones
  • The only way future mortgage payments will drop is if you recast your loan or refinance it
  • Make sure you have money in the bank after making any extra payments
  • The money could be trapped in your home and unavailable for other more pressing needs

If you made additional payments and want subsequent monthly payments to be lower, you have two options to get payment relief.

You can refinance the loan, which would also re-amortize the loan based on a brand new loan term. Of course, if you’re well into a 30-year loan, you’ll reset the clock if you go with another 30-year term.

That’s why it’s recommended to go with a shorter term loan when refinancing such as a 15-year fixed mortgage, which kind of defeats the purpose of lowering monthly payments.

The other option you might have is to request a “loan recast,” where the lender re-amortizes the loan based on the reduced principal balance.

This generally only makes sense if you make a sizable extra payment, something that would really change the payment structure of the loan.

In fact, some banks may only offer a recast it if you make a certain lump sum payment that cuts a certain percentage off the loan. They’ll also charge you a fee to do it in most cases.

So while both a refinance and a recast can lower monthly payments, you have to be careful not to tack on more costs as you attempt to pay your mortgage down faster.

At the end of the day, it can be very worthwhile to make larger payments even if your subsequent payments don’t change, just make sure you have money set aside for a rainy day.


When Should You Start Looking for a House?

The short answer: Immediately. That is, if you want to buy a home at some point in the next year, or any time thereafter.

We’ll get into the specifics in a moment, but there’s really no sense in waiting if you want to own a home or condo because it’s always going to be a lengthy process.

Sure, once you find “the one” it might only take a month, or even less, to close escrow, thanks to new technologies that are making the actual transactional piece faster.

But the transaction is just one slice of the pie, and usually the fastest part. Personally, whenever I’ve looked for real estate, it’s been a long, long search. We’re talking many months if not a year or longer.

Consider All Aspects of the Process

home buying timeline

  • Decide you want to buy a home (might be a long or short process)
  • Determine if you’re able to (seek out mortgage pre-approval)
  • Might need additional time to save for down payment and/or improve credit
  • Start looking at listings (set saved searches and alerts)
  • Find a real estate agent to work with (can be early on or late in the process)
  • Attend open houses, tour properties, and find one you like
  • Make an offer the seller accepts
  • Conduct inspections
  • Secure financing and close your loan

It’ll Probably Take You Over a Year to Find a Home

If we count the time from when you begin house hunting until your home purchase loan ultimately funds, there’s a decent chance 365 days will have elapsed.

I’m talking the day you first set your filters on Zillow/Redfin until the time the mortgage lender congratulates you on being a homeowner with an oversized key.

Does this mean each and every day is going to be consumed with home shopping? No, not at all. In fact, there might be days or weeks at a time during that span when nothing is brewing.

Your desired market could lie dormant if no new listings appear that fit within your specific parameters.

Of course, this is technically part of the process too. Waiting. And keeping an eye on things even when nothing is happening.

The good news is this will give you more time to prepare as a homeowner, especially if you’re going to be a first-time home buyer.

First Make Sure You Qualify for Home Loan Financing

  • The mortgage should come before the house
  • Not the other way around as some may lead you to believe
  • Know you can actually obtain financing and at what price point
  • Then start looking at suitable properties to ensure you don’t waste your time or anyone else’s

I’ve written an entire post about this, but I’ll reiterate here again. It’s probably not a good idea to start searching for a home until you know you qualify for a mortgage, assuming you’re not paying cash.

You wouldn’t shop for a new car if you didn’t have a steady job and money in the bank, so why shop for an even larger purchase without knowing where you stand?

Fortunately, it’s pretty easy to get a mortgage pre-approval, and even easier to get pre-qualified, though the latter isn’t worth a whole lot.

Either way, make sure you do one of the two to at least get a ballpark estimate of what you can afford. And to determine if there are any red flags that need to be addressed early on.

Credit is usually a biggie, and one that can take months to resolve if there are any glaring issues. Or if you simply need time to up your credit scores for more favorable mortgage rate pricing.

Anyway, once you know how much house you can afford, and that you’re more or less eligible for a home loan, you can begin your property search.

Set Up Your Property Searches and Get Email Updates

  • Only after you know you can obtain a home loan
  • Should you begin searching for properties in your price range
  • Companies like Zillow and Redfin are handy and offer nearly real-time updates
  • They allow you to set alerts and receive instant or daily emails when new properties hit the market

One of the best ways to search for a property these days is via Zillow or Redfin. Assuming they cover your particular metro, pretty much every house, condo, and townhome will be listed.

You’ll have a ton of key information at your fingertips, including listing price, days on market, number of bedrooms and bathrooms, square footage, sales history, recent comparable sales, and most importantly, pictures!

Most home sellers throw up 20-50 photos or more, so you can do most of your home shopping from the comfort of your own abode before even thinking about a tour.

The good thing about these sites is you can set up filters and saved searches, then elect to receive targeted emails daily or instantly.

So the minute something new pops up, you’ll receive an alert. Or you can wait and get all new listings for that day in one shot.

Assuming you followed step one and got pre-approved for a mortgage, while simultaneously getting all your ducks in a row otherwise, you’ll be ready to pounce at a moment’s notice.

And these days, with the real estate market so hot, you might not get a chance to hesitate (see my 2021 home buying tips for more on that).

However, for most folks, the search process will take over a year, so there’s not necessarily a big rush.

Tip: If it’s a pocket listing or for some reason not on the MLS, the property may not show up on these websites. But this is less likely and even then, it may not be what you’re looking for or readily available.

Select an Experienced Real Estate Agent

  • Most home buyers will use a real estate agent to get the job done despite there being other options
  • You can choose to work with one early on in the discovery process
  • Or do the pre-qualifying and home shopping on your own before selecting one
  • Then you can have them come in just for the negotiation and paperwork when you find a house you like

Another thing you’ll need to take care of along the way is choosing a real estate agent to work with, that is, if you don’t go it alone.

Most home buyers work with agents, so there’s a good chance you will too. Add this selection process onto your home search timeline.

It can happen while you’re looking at prospective homes, or once you’ve already found one. You might know an agent and just tell them to be ready for you once you find your ideal home.

Or you might want some more hand-holding and seek out an agent without delay, who hopefully will get you organized and prepped immediately to avoid any missteps.

I like the idea of doing some stuff on your own first without any input from interested parties so you can explore and figure things out without bias.

But everyone is different and may not have the time, patience, or ability to do so.

Anyway, an agent can send you updates when new listings hit the market as well and basically be a more hands-on guide if you want/need it.

They can take part immediately or enter the conversation at a later date. It’s really up to you on how they fit in.

Tip: You can fly solo and once you find a home you like, use the listing agent as your buying agent to perhaps give you a leg up on the competition. Just be sure they have your best interests in mind too.

There Are Plenty of Houses in the…

  • It’s easy to fall in love with a house at first sight
  • And experience major FOMO along the way
  • But you’ll probably see 10+ properties in person
  • Before finding the right one (so try to temper your emotions)

I think we all have a tendency to fall in love with the homes we see in person, especially as first-timers, but it’s important to physically visit multiple properties to gain perspective.

These days you can see 50+ photos of a property before committing to a tour. So if you’ve made it that far there’s a good chance you’re into it.

Sure, you can arrive at the property in question and be completely underwhelmed, but if do like what you see, it might be hard to walk away.

And even harder not to imagine yourself living there. And decorating it exactly how you wish.

The best line I can think of here is that there are plenty more fish in the sea. Don’t get caught up on that first property, or any property in particular.

Aside from potentially overpaying, often times, you’ll look back and be grateful that you didn’t buy that one house, or you’ll be glad you got outbid by another buyer, etc.

You might get lucky and find that right house in a week, but chances are you won’t. Or it might just feel like the right one until you dig deeper and see more of what’s out there.

Tip: Per the National Association of Realtors, buyers see an average of 10 homes before making an offer. So prepare yourself mentally.

Okay, So How Long Does It Take to Buy a House?

  • The average time it takes to find a house might be 4-6 months
  • But it depends when we actually start the clock
  • Many buyers dip their toes for a while before getting more serious
  • We also have to factor in the many steps including financial prep, selecting an agent, house hunting, and loan closing

While results will vary, maybe tremendously, most industry experts say it’ll take anywhere from four to six months to buy a house, if not longer.

Thing is, it depends when the clock starts ticking. Do we start counting when you first open the Redfin or Zillow app, or do we start counting once you’ve met with a real estate agent?

These days, prospective buyers do a lot on their own before making contact with anyone. Or making it known that they’re even in the market to buy.

They may go through their own little discovery period where they weigh the pros and cons of homeownership, potentially for months.

As noted, it’s advisable to get in touch with a bank, lender, or mortgage broker just to know you qualify for a mortgage. Technically, this could count as the start of the home buying process.

The real estate agent part can be put off until you get more serious about buying a home because of the technology available these days.

We no longer need to be driven around the neighborhood by a friendly real estate agent in their Mercedes-Benz.

So really, the agent can come in during the late stages and help you close the deal, maybe only working with you for a month or so with the offer, paperwork, inspections, and loan closing.

But chances are they’ll come in earlier and send you listings or be on the lookout for properties that might make sense.

Then we have to take into account the home loan process, which can take anywhere from 30-45 days or longer.

If we round that up to two months and add a couple months of looking, we’re already around four months.

But the odds of finding your dream home in two months might be quite low if you’re a picky buyer, which you should be in most cases.

In reality, you could be looking for six months before you find something you like, then once you submit an offer and get your mortgage, it’s seven or eight months.

Factor in the time you were thinking about buying a home for a few months before that, the general financial preparation (saving for a down payment, getting credit in order, etc.), and the pre-approval piece, and you’re at a year in many cases.

To summarize, it going to take a while, and that’s totally okay. It’s not a process that should be rushed.

In fact, the more time that goes by, the more knowledgeable you should become. And you can mentally prepare for homeownership at the same time. That’s a good thing.

Read more: When should I buy a house?


Should You Buy a New Home or an Old Home?

It’s time for another match-up, this time we’ll compare buying a new home versus purchasing an old one.

For the record, some home builders refer to existing homes as “used,” which sounds kind of silly considering we’re talking about a house and not a car.

Ultimately, it’s a marketing gimmick to sway you toward buying new as opposed to old, but let’s continue on to determine the pros and cons.

Millennials and Gen X Are Big on New Homes

types of home buyers

A recent report from the National Association of Home Builders found that interest in newly-built homes has surged.

They noted that during the fourth quarter of 2020, 41% of prospective buyers were searching for a newly-built home, double the 19% share a year earlier.

At the same time, the share interested in an existing home fell from 40% to 30%.

It’s even more pronounced when we break it down by generation, with 50% of Millennial and 48% of Gen X buyers looking to buy a new home.

Meanwhile, just 13% of Boomers indicated that they were looking for a new home vs. existing.

Interestingly, Gen Z is a little more into existing homes than Boomers with a 38% share, but still below that of Millennials and Gen X.

New Homes Are Untouched and Clean

  • The number one reason to buy a new home is probably the fact that it’s never been lived in
  • Some people may not like the idea of living somewhere that was previously occupied
  • It also might feature the newest amenities such as improved insulation and solar panels
  • And in theory you shouldn’t have to repair or renovate anything right away

The most obvious benefit to buying a new home as opposed to an old, existing, or used one is the fact that it’s brand spanking new.

It’s untouched, it’s clean, everything is in good working order and nothing needs to be repaired. At least that’s the hope.

That’s a pretty huge incentive to buy new. You won’t have to worry about the typical costs of homeownership for the first several years, right?

Another benefit to buying new is that the home (or townhouse or condo) should have all the latest amenities.

Remember when it was all the rage to have stainless steel appliances and granite countertops?

Well, today’s new homes come with solar panels, energy-saving windows, smart appliances, USB outlets, electric vehicle charging stations, thermostats and door locks you can control with your phone, and other features that might make your used home look really old, especially a few years down the line.

Aesthetics aside, these upgrades could actually save you a lot of money each year on utility costs because they’re designed to be cost-efficient, not just handy.  You might even get a tax break!

Not only that, but many of these new homes use low-VOC paints and flooring, which are supposedly better for your health. Who knows what lurks in some of the older homes?

Additionally, new home buyers often get the opportunity to fine-tune the home they buy by selecting certain features, colors, styles, etc., and even financing any add-ons into the mortgage loan amount.

It Can Be Easier to Buy a New Home

  • It might be easier to finance a new home with a mortgage
  • Home builders often have their own home loan divisions
  • So they’ll be motivated to work with you to get the deal done
  • But still take the time to shop around and negotiate since you don’t need to use their preferred company

And speaking of mortgages, most home builders have their own financing departments that make it easy to get a mortgage.

Whether it’s the best deal is another question, but if you simply want in, your odds are probably better with a new home.  After all, the builder has a vested interest to get you financing.

There’s probably also a lot less competition for a new home, seeing that you’re probably checking out a brand new neighborhood full of vacant homes to choose from.

This can be a huge advantage in a seller’s market, which we’re experiencing at the moment. Instead of a bidding war, you might be able to pick and choose from a selection of available properties.

You can even pick among different sizes and floor plans to get just the right amount of space, as opposed to having to conform to what’s available in the existing market.

You might be thinking, hey, this sounds great, sign me up now! Why on earth would I want a used home with dodgy popcorn ceilings and laminate countertops?

But wait, there’s more to homes than their shiny exteriors and what’s inside.

Don’t Forget About Location…

  • Location is and will always be the biggest property value driver
  • And new construction homes are often in less desirable areas
  • Or in the outskirts of urban areas because that’s where new land is available
  • Be sure to take that into consideration as a major tradeoff to buying a new home

Let’s face it; the old adage that location is everything in real estate is true. It’s always been true, and always will be true. That is, if you want to see your property actually go up in value.

And guess what. Brand new homes often ren’t being built in the best locations. When it comes down to it, there’s no space for a new development in an established or central location.

Sure, you might see a new condo development, but new homes most likely won’t be that central. They’ll be on the outskirts of town, or in a “trendy” or “up-and-coming” area.

In other words, there’s going to be a commute if you buy new, and the location might be questionable at best in terms of value.

There might even be multiple new developments surrounding yours, with tractors and hammering construction workers doing what they do all day long.

That being said, it is possible to buy a new home in an area that flourishes. One hint it’s the right area might be the stores that are built nearby, such as a Whole Food’s or Trader Joe’s.

Of course, with an existing or used home, you can buy in the heart of the city, or in an area you know well that is insulated by a lack of available space and construction.

That buffer means the property should hold up well in terms of value, even during a downturn, assuming the area isn’t subject to obsolescence.

A used home might also give you the ability to walk to work, or to popular restaurants, bars, shops, and so on.

At the same time, a used home doesn’t necessarily have to be old inside. If you shop around, you might be able to find an old home that has already been remodeled to your liking.

And even if it hasn’t, that shouldn’t stop you from buying it and making renovations if it’s got good bones.

New Homes Are 20% More Expensive

  • Ultimately you pay a premium for a new home (just like a brand new car)
  • Apparently the cost is 20% more on average per a study from Trulia
  • So while a new home might be cheaper with regard to maintenance and renovation
  • You still need to consider the upfront cost to get an apples-to-apples comparison

A while back, Trulia determined that new homes (built in 2013-2014) cost roughly 20% more than similar existing homes.

They also found that two in five Americans would prefer to buy a new home, compared to just 21% opting for an existing home and 38% declaring no preference.

But when it came to that 20% markup, only 17% would actually pay the premium to get the new house.

So to get this straight, you might have to pay 20% for a new home AND you won’t be in a central location.

You’ll be in an untested location that might wind up being a ghost neighborhood in a decade if things don’t work out as planned.

During the most recent housing crisis, a lot of new home communities were hit the hardest, whereas existing homes saw their values decline but prop back up over time.

Of course, if you opt for new you’ll probably have all the latest technology and no major issues.

And if you go with an older home, you might have major bills on your hands when the roof gives out, or you discover serious plumbing issues.

So you’ll need to do your due diligence when buying an old home to ensure the property is in adequate shape. This means paying for a quality inspection (or two).

Then again, I’ve heard really negative stuff about new homes too, with many claiming workmanship has gone to you know what these days.

In other words, you’re not out of woods if you buy new either, though there might be some kind of warranty in place for a while.

At the end of the day, it’s probably okay to consider both new and used homes when looking for a property, and including both types should increase your odds of finding a winner.

As long as you take the time to inspect the property and the neighborhood, negotiate the right place, and make sure you can afford the place, you should be okay.

Lastly, you should make sure you actually want to own as opposed to rent because owning comes with many more responsibilities, whether you buy new or used.

Advantages to Buying a New Home

  • Brand new, clean, no major issues
  • Move-in ready (no wait or work to be done)
  • Cool new technology
  • Green features could reduce utility costs and/or provide tax incentives
  • Trendy design
  • Ability to customize
  • Can finance additions into mortgage
  • Possibly easier to get financing with home builder
  • Less competition, more choices on floor plans

Disadvantages to Buying a New Home

  • More expensive than buying used
  • Location probably isn’t ideal
  • Despite being new, workmanship might be questionable
  • Could be subject to costly HOAs, even if it’s a house
  • Neighborhood dynamic is unknown
  • Property values might be more volatile
  • Construction nearby (eyesore and noisy)
  • More cookie-cutter, less unique

Advantages to Buying an Existing Home

  • Possibly cheaper
  • Better, more central location
  • Can buy in an established school district
  • Can own in a more reputable and recognized neighborhood
  • Old house might have new upgrades
  • You can always renovate if need be
  • Older houses tend to have more character, custom design
  • Could actually be built better than a new home

Disadvantages to Buying an Existing Home

  • Harder to find an existing home (less inventory)
  • Might have major problems you don’t initially notice
  • Financing could be tricky (if unpermitted work, etc.)
  • Could still be more expensive than buying new
  • Fewer amenities, especially as homes get more tech-integrated
  • The neighborhood might be in decline
  • More competition to get your offer accepted
  • Might have to settle for a smaller, less ideal home to get right location


Am I Ready to Buy a House? 8 Questions to Help You Decide

So lately you’ve found yourself asking, “am I ready to buy a house?” Homeownership is a major milestone that many people dream of reaching one day. However, there are a variety of factors to consider when making one of the biggest financial decisions of your life. 

So, if you’ve been thinking about becoming a homeowner, but aren’t sure if you’re prepared, you’ve come to the right place. We’ve laid out 8 questions to help you decide if you’re finally ready to buy a house. See how many you can answer yes to and if now is the right time for you to begin your homebuying journey.

am I ready to buy a house

am I ready to buy a house

1. Do you have money for a down payment?

Although the common perception is that first-time homebuyers need to have a 20% down payment to purchase a home, that’s simply not the case. Typically you’ll need a minimum down payment of 3.5% to 10% for an FHA home loan, and a minimum of 3% to 5% for a conventional loan. 

For example, let’s assume you’d like to purchase a home that costs $300,000. Your lender will require a downpayment of at least 3% of the sale price of the home, depending on the type of loan you choose and qualify for. In this example, 3% of $300,000 equals a $9,000 down payment.

It’s important to remember that the larger your down payment, however, the lower your monthly payments will be and the less interest you will pay during the life of your loan. Another drawback to a low down payment is that you’ll have to pay private mortgage insurance (PMI), which protects your lender in case you can’t pay your mortgage. If you put down less than 20%, you’ll probably have to pay for PMI, which is added to your monthly mortgage payment.

2. Do you have a solid savings and emergency fund?

While you may have saved enough for your down payment, don’t forget to account for closing costs which include legal fees, lender fees, taxes, etc., and usually total 2% to 5% of the home’s purchase price. Also, during the home inspection, you may find a few home maintenance items that you’ll want to take care of sooner rather than later, such as a leaking septic tank or cracks in the walls or ceilings. This is when additional savings will come in handy.

You should also make sure you have some emergency funds set aside. When you’re renting, you have the wonderful luxury of calling up a landlord whenever there are issues with the property. So when the heater stops working in the middle of winter, you don’t have to spend thousands of dollars to fix it. Or, when your washing machine breaks during a cycle, you won’t be responsible for calling a repairman to take a look. But once you become a homeowner, all of that responsibility falls on you. So, if you’re going to burn through your savings on a down payment, hold off on buying a house until you have a larger safety net. 

3. Is your credit score in pretty good shape?

Many potential homebuyers worry that they won’t be able to buy because of a low credit score. However, you actually don’t need perfect credit to buy a home and there are many loans and first-time homebuyer programs available for buyers without perfect credit. That being said, a higher score will help you qualify for a lower mortgage rate, saving you money in the long run.

One of the most common questions first-time buyers ask is, “what credit score is needed to buy a house?” While there’s no hard-and-fast rule for this, you’ll likely need a minimum credit score of 600 for approval. To qualify for the most favorable rate, however, work on improving your credit score and wait until you have a score of 700 or higher.

4. Do you have a handle on your debt?

Don’t panic – you don’t have to be completely debt-free to buy a home. Between student loans, car payments, and other bills, most mortgage companies know that it is unrealistic to expect borrowers to be totally debt-free these days. They primarily want to know that you’ll be able to afford your mortgage payment based on how much money you have coming in versus what you need to pay out to other debts. 

To figure this out, lenders will look at your debt-to-income ratio, which is an estimation of how much of your monthly income goes towards debt payments. To find your current ratio, you can use a debt-to-income ratio calculator. So long as your debt ratio is at least 43% you can still qualify for a mortgage.

facts about va loans

5. Have you crunched the numbers to make sure you can afford the monthly expenses?

To figure out if you can afford the monthly expenses, you’ll first need to calculate your mortgage payment. An online mortgage calculator can estimate this for you, however, affording a home is so much more than just the mortgage payment. Other financial aspects of homeownership may include:

  • Property taxes and insurance
  • Home Owner Association (HOA) fees, if applicable
  • Home expenses (sewage, garbage, internet, etc)
  • Utilities (water, electricity, etc.)

Before you decide to make the transition from renting to buying a house, make sure you’ve done the math and can afford all of the monthly expenses that come with being a homeowner.

6. Do you have a steady job?

Stable employment and income show lenders how much house you can afford and are important indicators for qualifying for any mortgage. But even if you can demonstrate financial stability on paper, you should only buy a house if you think your income will remain steady for the foreseeable future. 

A nightmare scenario for most homebuyers is losing their job just after they close or move into a new home. So if there’s any uncertainty about your income or employment, wait until things settle down before buying a house.

7. Do you need more space?

While money is obviously an important consideration, there are many other factors to think about when asking, “am I ready to buy a house?” One of which is the thing we all seem to need more of currently – space. 

With so many of us spending most of our time at home, maybe you desperately need a designated home office or an extra room for a home gym? You may want a larger backyard or an area for a garden. Do you have kids or are you expecting a baby soon and you need more room? If this sounds like you, then now may be the time to consider buying a home.

8. Are you planning on staying put for a while?

There’s no rule barring you from moving shortly after buying a home. But as a homeowner, you’ll have a chance to build equity. The longer you own your home, the more equity you build, and the more money you’re likely to make when you sell it. Ideally, you should live in a house long enough to make a profit. So, if you can’t commit to an area, continue renting until you’re ready to put down roots.

Figuring out if you are ready to buy a house is a personal decision and one that means taking a hard look at different aspects of your life: finances, lifestyle, job situation, and long-term goals. But if you’ve answered yes to all of the above, you might just have an answer to the big question, “am I ready to buy a house?”  If you’re still unsure or you have specific questions relating to your situation, reach out to a mortgage lender or real estate agent who can give you professional advice. 


6 First Time Home Buying Myths Debunked

Buying your first home is often a dream for many renters out there. But with all the information about how to buy a home, it can be easy to believe some of the home buying myths. Whether you’re looking to buy a house in Seattle, WA, or a condo in Miami, FL, you’ve probably heard some of the myths surrounding how much you’ll need for a down payment or how high your credit score should be. 

Before you set your sights on your dream home, make sure you know just what separates the home buying myths from the facts. You may realize that you’re able to buy your first home sooner than you think.



MYTH 1: You need a 20% down payment

The biggest home buying myth for any first time homebuyer is that you need a 20% down payment to buy a home. In many cases, your down payment can be as low as 3.5%. Common types of loans with low to no down payments include FHA, VA, and USDA loans. With FHA loans – loans designed for individuals with a low-to-moderate income level and credit score- your down payment could be as low as 3.5%. For veterans and current service members, VA loans offer no down payment mortgages, and those looking to buy a home in a rural area may qualify for a no down payment USDA loan. 

Aside from loans, down payment assistance programs can help you lower the cost of your down payment. These programs are available nationwide, statewide, or locally in your county or even city. Down payment assistance programs provide a wide range of assistance types such as second mortgages, forgivable loans, or grants covering partial to full costs of your down payment. Your real estate agent or mortgage lender can help you determine what down payment assistance you qualify for. 

If you do have the means to purchase a home with a 20% down payment, there are benefits to consider. For starters, you won’t need to factor in private mortgage insurance (PMI) to your budget. PMI is an additional cost your mortgage lender may require if your down payment is below 20% and the cost is factored into your monthly mortgage payment. However, it’s always a good idea to talk with your financial advisor or wealth manager to determine your finances and whether a 20% down payment is the right option.

MYTH 2: Renting is cheaper than buying a home

One of the most common home buying myths is that renting is cheaper than buying a home. If you’re deciding whether to make the transition from renter to buyer, you might believe that renting is the less expensive option. However, in some cities the cost of renting a home may be less than or equal to a monthly mortgage payment.

If you’re serious about buying a home, you may end up saving money in the long run if you buy a house rather than continue renting. To compare the costs of renting versus buying a home, you can use a rent vs buy calculator to determine which option works best for your circumstances.

MYTH 3: Your credit score needs to be perfect

Home buying myths centered around credit scores often run rampant, specifically the myth that you must have a great credit score to buy a home. Luckily, that’s not always the case. If your credit score is at least 580, you may qualify for a 3.5% down payment FHA loan. For those looking at USDA loans, your credit score should also be a minimum of 580. VA loans actually have no minimum credit score, but instead require lenders to look at the whole loan profile of a homebuyer.

Generally speaking, if your credit score is higher you’ll likely have more options when it comes to qualifying for a conventional loan. With a higher credit score, you may also find that the terms of your loan or interest rates are better. However, just because your credit score isn’t great doesn’t mean your homeownership dreams need to come to a halt.

MYTH 4: All mortgage lenders offer the same rate

First time home buyers may have the belief that every mortgage lender will offer you the same rate no matter where you go. When shopping for a mortgage, it’s always a good idea to get more than one quote. Not every mortgage lender will offer you the same – or even the best- loan terms. To avoid making this mistake, it’s important to get quotes from several mortgage lenders and find the one that’s best suited for your finances and homeownership goals. 

MYTH 5: Home inspections are optional

Especially if there are bidding wars, it can be tempting to skip a home inspection to make your offer stand out. However, home buying myths like these may cause more issues down the road. More often than not, mortgage lenders will require a home inspection before you buy the home, so you may not even have the chance to consider passing on a home inspection.

In the case that your lender does not require an inspection, this doesn’t mean you should skip it. It’s important to know the condition of the home you’re looking to buy. That way you’ll be aware of any damage or issues the house may have before becoming the owner. If a home inspection does find any significant damage, you may be able to negotiate with the seller to repair the issues or lower your asking price. 

MYTH 6: The listing price is non-negotiable

A home buying myth that some first time homebuyers believe is that the listing price is set in stone. Depending on the housing market, you may need to be prepared to spend more than the home’s list price or negotiate for a lower price. If you’re buying in a seller’s market– where there are more buyers than homes available- you should be prepared to make an offer that’s higher than the listing price.

If it’s a buyer’s market- where there are more homes available than buyers looking to purchase- you may be able to negotiate for a lower price than what’s listed. Either way, believing the home buying myths about listing prices may cause you to lose out or even overspend on the home of your dreams.


When Are Mortgage Rates Lowest?

We’re all looking for an angle, especially if it’ll save us some money.

Whether it’s a stock market trend, a home price trend, or a mortgage rate trend, someone always claims to have unlocked the code.

Unfortunately, it’s usually all nonsense, or predicated on the belief that what happened in the past will occur again in the future.

Sometimes history repeats itself, sometimes it doesn’t. We probably only hear about the times when it does because it makes the individual behind it sound like a genius.

In reality, it’s very difficult to predict anything, even the weather, so when it comes to complex stuff like mortgage interest rates, success rates probably move a lot lower.

That being said, I set out to see if there were any mortgage rate trends we could glean from available data, using Freddie Mac’s historical mortgage rates that go back to 1971.

Using 50 years of data, you would think some trends would appear, right?

Were mortgage rates lower in certain months, higher during others, or is it all just random? Let’s find out.

What Time of Year Are Mortgage Rates the Lowest?

mortgage rates by month

I looked at monthly averages for the 30-year fixed-rate mortgage over the past three decades to determine if there’s a winning month out there.

It turns out there is a month when mortgage rates are lowest, and as you might expect, it’s at a time when most folks wouldn’t even be thinking about purchasing a home or refinancing an existing mortgage.

Yes, it’s December. You know, when individuals are more concerned with holiday shopping and traveling to see family then calling up a mortgage lender.

This could explain why mortgage rates are lowest in December. If you recall, lenders pass on bigger discounts to consumers when things are slow.

As alluded to, December is always going to be a slow month for mortgage lenders, which probably has something to do with the discount seen over the past 30 years.

Keep an Eye Out for a Mortgage Rate Sale

  • Mortgage lenders operate just like other types of businesses selling products or goods
  • They price their loans based on expected profit margin and operational costs
  • If their business slows down they might be inclined to lower the price (or interest rate)
  • But if they’re doing a lot of business (or even too busy) they might keep rates artificially high

Similar to any other company out there selling goods, there are “sales” at certain times throughout the year, and also times when prices are marked up.

As you might expect, if a company is trying to move product, in this case home loans, what do they do? They lower the price to drive business.

Mortgage lenders able to lower the price, or rate, because they’ve got a margin built in to their market rate.

This margin acts as their profit, minus operational costs. Sure,they may not make as much per loan if they lower rates for consumers, but they could make up for it on volume.

Instead of closing one higher-priced loan, they might be happy to close three loans and earn more on aggregate. So they have wiggle room to play with rates a bit.

They can adjust them lower when business is crawling, and simply maintain or raise them when their phone won’t stop ringing.

How Much Cheaper Can They Really Be?

  • While mortgage rates are measured in eighths of a percent (0.125%)
  • Which may look or sound like absolutely nothing when comparing rates
  • The small difference can be exponential because you pay the mortgage each month for years (possibly 30!)
  • This explains why even a marginal difference in rate can amount of thousands of dollars over time

Okay, so we know rates vary throughout the year, and even a small difference in rate can be very meaningful. But how much can you really save?

While not massive by any stretch, you might be able to get a rate .25% lower in December versus April. Same goes for October and November compared to spring.

If we’re talking about a $300,000 loan amount, a rate of 2.75% vs. 3% is the difference of roughly $40 per month, or nearly $500 per year.

Keep your mortgage for a decade and you’ll pay nearly $5,000 more over that period.

Are You Overpaying for Your Home Loan and House in April?

  • The most common time to buy a home is in spring, namely April
  • This is when prospective buyers get serious and make offers
  • It’s also when more home sellers finally agree to list their properties
  • But it might be cheaper to buy a home during fall or winter

Now speaking of April, that month tends to be prime time for home buying historically, which explains the lack of a discount.

The same goes for buying a home during April – it’s a lot less common to see a price reduction during spring than it is during fall or winter.

It all begs the question; should we buy homes when prices, competition, and interest rates are lowest? Probably.

Just one problem – there tends to be less available inventory in the fall and winter months as well. But if you do come across something you like, it could be a great time to snag a deal.

In other words, you should always be looking, even if it’s not the ideal time to move.

If you’re refinancing a mortgage, there are less obstacles in December since you’ve already got a house.

To sweeten the deal, lenders probably aren’t busy, so you’ll breeze through underwriting a lot quicker. And you could receive a little more attention from your loan officer.

Should I Wait Until December to Get a Mortgage?

In short, probably not. While December had the lowest mortgage rates on average over the past 30 years, there were plenty of years when rates were higher in December compared to other months.

Take 2018, where the 30-year fixed averaged 4.03% in January and 4.64% in December.

Same goes for 2015 and 2016, when rates were markedly higher in December versus the beginning of the year.

However, in 2020 the 30-year fixed averaged 3.31% in April and 2.68% in December, which is a difference of 0.63%. That can equate to thousands of dollars in savings.

All in all, you’re probably better off paying attention to what’s going on in economy if you want to predict the direction of mortgage rates.

The trend (moving up or down over a period of time) might be more important than the month of year.

Simply put, bad economic news generally leads to lower mortgage rates, whereas positive news tends to propel interest rates higher.

Time of year aside, you might be able to save even more on your mortgage simply by gathering quotes from more than one lender.

Ultimately, timing doesn’t seem to be the biggest driver of rates, nor is it something most of us can control anyway.

(photo: Marco Verch)

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Mortgage Impounds vs. Paying Taxes and Insurance Yourself

Posted on October 21st, 2020

If you’ve been researching mortgages, or are in the process of taking out a home loan, you’ve probably come across the term “impounds” or “escrows.”

When you hear these seemingly scary words, the loan officer or mortgage broker is referring to an impound account, also known as an escrow account.

You may even be told you have to pay to remove them, or possibly accept a higher interest rate in return. Let’s learn why.

What Are Mortgage Impounds?

mortgage impounds

  • Impounds or escrows as they’re also known
  • Refers to the automatic collection of property taxes and insurance
  • It ensures you always have funds available to make these important payments
  • A portion is taken out of your housing payment each month and set aside until due

As the name implies, it is an account managed by a third-party, typically a loan servicer, to collect and disperse funds on behalf of the homeowner and lender.

Homeowners pay money into the escrow account at closing and each month after that with their mortgage payment.

Over time, the balance grows and when property taxes and homeowners insurance are due, the money is sent on to the tax collector or insurance company, respectively.

Instead of paying property taxes twice a year, or homeowners insurance once annually, you pay a considerably smaller installment amount each month instead.

This is where the acronym “PITI” comes from – Principal, Interest, Taxes, and Insurance.

You must also pay an “initial escrow deposit” at loan closing, which will vary greatly based on the month you close, and where the property is located.

Lenders may also collect one or two extra months of payments to act as a cushion for future increases in taxes and insurance, but this amount is strictly regulated.

Why Mortgage Impounds?

  • They basically protect the lender from borrower default
  • Assuming the homeowner falls behind on taxes or fails to make insurance payments
  • The monthly collection of funds ensures the money will be available when payments are due
  • And alleviates a situation where the borrower is unable to make what are often very large payments

An impound account greatly benefits the lender because they know your property taxes will be paid on time, and that your homeowners insurance won’t lapse.

After all, if you have to pay it all in one lump sum, there’s a chance you won’t have the necessary cash on hand.

Remember, the average American has little to no savings, so if a big payment is due, uh-oh!

Clearly this is important because the lender, NOT you, is the one that truly owns your home when you’ve got a giant mortgage tied to it.

And they don’t want anything to come in between the interest in THEIR property in the event you’re unable to make these critical payments.

Many seem to think lenders require impounds so they can earn interest on your money, but it’s really to protect their interest in the property.

*Some states require lenders to pay homeowners interest on their impound account balances.

In California for example, it is customary for mortgage escrow accounts to earn interest. Each year you should receive a tax form that shows what you were paid and what you OWE as a result.

Be sure to check your own state law to determine if you’ll earn interest. In any case, it likely won’t be very much money, and it’s taxable…

Impound accounts can also benefit borrowers because the money is collected gradually over time, so there isn’t that big unexpected hit when taxes or insurance are due.

For this reason, some borrowers actually prefer impound accounts, especially those that tend to do a poor job managing their own finances.

And you shouldn’t miss a payment or pay late because it’s all done for you automatically.

[Homeowners insurance vs. mortgage insurance]

Paying Property Taxes and Homeowners Insurance Yourself

  • You should have the option to pay these bills yourself
  • But only on certain types of mortgage loans
  • Such as conventional loans or those where you put down 20% or more
  • But it may cost you .125% of the loan amount

If you’re the type that likes full control over your money, you can always pay your property taxes and homeowners insurance yourself if the underlying loan allows for it.

In this case, you “waive impounds,” which usually entails paying a fee, such as .125% or .25% of the loan amount at closing.

For example, if your loan amount is $200,000, you might be looking at a cost of $250 to $500 to remove impounds.

Of course, waiving impounds/escrows may also come in the form of a slightly higher mortgage rate if you don’t want to pay the escrow waiver fee out-of-pocket.

Either way, there is typically a cost, though you can always try to negotiate with the lender to get them waived and still secure a low rate.

Just keep in mind that you can’t always waive impounds.

Impounds are required on FHA loans, VA loans, and USDA loans.

For conventional loans, impounds are generally required if you put less than 20% down.

And even then, many lenders now charge borrowers if they want to waive impounds, even if their loan-to-value ratio is super low.

In California, impounds are only required if the loan-to-value ratio (LTV) is 90% or higher. But you may still have to pay to waive escrows either way.

It’s seemingly unfair, but like all other businesses, they got creative and came up with yet another thing to charge you for. Sadly, you should be used to this by now.

How to Remove Impounds

  • You can request the removal of impounds once your LTV is at/below 80%
  • So either by paying down your loan over time or via lump sum payment
  • But there’s no guarantee the lender will agree to do so

If you initially set up an escrow account, you may be able to get it removed later down the line.

Simply contact your loan servicer and ask them to review your escrow account.

As a rule of thumb, it’s more likely to get approved if your LTV is at or below 80%. That way they know you’ve got skin in the game.

That 20% in home equity gives the lender sufficient protection from potential default if you fail to pay property taxes or home insurance in a timely fashion.

The Annual Escrow Analysis

  • Loan servicers are required by law to review your escrow account annually
  • This happens once a year on your origination date to ensure it’s balanced
  • If you paid too much you may receive an escrow surplus refund check
  • If you didn’t pay enough you may need to pay an escrow shortage

Each year on the anniversary date of your loan closing, your lender is required by federal law to audit your impound account and refund any excess over the allowable cushion.

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You will also receive an escrow analysis statement that can be handy to look over.

Generally, the minimum balance required for an escrow account is two months of escrow payments, which covers any increases in taxes and insurance.

When your loan servicer projects the numbers for the year ahead, any surplus, which is your estimated lowest account balance minus the minimum required balance, will be refunded to you.

If your account balance is higher than this minimum amount, you may be refunded the difference via check. It’s a nice surprise when it comes in the mail.

Assuming you aren’t just sent a check that can be cashed, you may get the option to apply any overage to principal reduction or to a future mortgage payment.

You can also be proactive if it appears as if your impound account is a little too full. Simply call and ask them to take a look via an escrow account overage analysis.

It’s also possible that you may experience an escrow shortage, in which case you’ll be billed for the amount needed to satisfy the shortfall.

While not as nice as a check, it indicates that you haven’t been overpaying throughout the year.

The loan servicer may also give you the option to accept a higher monthly payment going forward to catch up on any shortage.

Note that both an escrow account surplus and shortage can result in a different monthly mortgage payment going forward, since they will collect more or less from you in the future.

For example, if you were paying too much last year, you might be told that your new monthly payment is X dollars less. Another unexpected surprise!

If you were paying too little, the reverse might be true – your mortgage payment may go up!

It’s Always Your Responsibility to Pay on Time

  • Regardless of how you pay taxes and insurance
  • It’s always your sole responsbility to ensure they’re paid on time
  • You can’t blame the mortgage lender/servicer if they slip up
  • So always follow up to make sure the payments are made on time

Regardless of whether you go with impounds or decide to waive them, it is your responsibility to ensure that your property taxes and insurance are paid on time, each and every year.

Sure, your loan servicer will probably pay on time, but this may not always be the case. Mistakes happen.

Also, if you’re subject to paying supplemental property taxes, your loan servicer may tell you that it’s your responsibility to take care of them on your own.

If you receive a supplemental property tax bill in the mail, you may want to call your servicer immediately to determine if it will be paid via your escrow account. If not, you’ll need to send payment yourself.

Situations like these are a good reminder to always keep an eye on your escrow account, and to keep solid records of your taxes and insurance.

In summary, it can be nice for someone else to handle these payments on your behalf, but you still have to make sure they’re doing their job!

(photo: Constantine Agustin)

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15-Year Fixed vs. 30-Year Fixed: The Pros and Cons

Last updated on November 19th, 2019

It’s that time again, where I take a look at a pair of popular mortgage programs to determine which may better suit certain situations.

Today’s match-up: “15-year fixed mortgage vs. 30-year fixed mortgage.”

As always, there is no one-size-fits-all solution because everyone is different and may have varying real estate and financial goals.

For example, it depends if we’re talking about a home purchase or a mortgage refinance.

Or if you’re a first-time home buyer with nothing in your bank account or a seasoned homeowner close to retirement.

Ultimately, for home buyers who can only muster a low down payment, a 30-year fixed-rate mortgage will likely be the only option from an affordability and qualifying standpoint.

So for some, the argument isn’t even an argument, it’s over before it starts.

But let’s explore the key differences between these loan programs so you know what you’re getting into.

What’s Better: A 30-Year Fixed or 15-Year Fixed?

30 vs 15 fixed mortgage

Two of the most commonly utilized home loan products available to homeowners today are the 15-year fixed-rate mortgage and the 30-year fixed mortgage.

They are very similar to one another in the way they function (both offer fixed rates for the entire loan term), but one is paid off in half the amount of time.

That can amount to some serious cost differences and financial outcomes.

While it’s impossible to universally choose one over the other, we can certainly highlight some of the benefits and drawbacks of each.

As seen in the chart above, the 30-year fixed is cheaper on a monthly basis, but more expensive long-term because of the greater interest expense.

The 30-year mortgage rate will also be higher relative to the 15-year fixed to pay for the convenience of an additional 15 years of fixed rate goodness.

Meanwhile, the 15-year fixed will cost a lot more each month, but save you quite a bit over the shorter loan term thanks in part to the lower interest rate offered.

15-Year Fixed Mortgages Aren’t Nearly as Popular

15-year fixed mortgage

  • The 15-year fixed is the second most popular home loan program available
  • But only accounts for something like 15% of all mortgages
  • Mainly because they aren’t very affordable to most people
  • With monthly payments around 1.5X the 30-year fixed

The 30-year fixed-rate mortgage is easily the most popular loan program available today.

Around 70% of all mortgages are 30-year fixed products, whereas the percentage of mortgages that are 15-year fixed loans is roughly 15%.

While this number can certainly fluctuate over time, it should give you a good idea of how many borrowers go with a 30-year mortgage vs. 15-year mortgage.

If we drill down even further, about 90% of purchase mortgages are 30-year fixed loans, and just about six percent are 15-year fixed loans. But why?

Well, the simplest answer is that the 30-year mortgage is cheaper, much cheaper than the 15-year, because you get twice as long to pay it off.

Most mortgages are based on a 30-year amortization, whether they are fixed or not (even ARMs), meaning they take 30 full years to pay off.

The 30-year fixed is the most straightforward home loan program out there because it never adjusts during this industry standard 30-year term.

The lengthy mortgage term allows home buyers to purchase relatively expensive real estate without breaking the bank, even if they come in with a low down payment.

It also means paying off your mortgage will take a long, long time…

In short, it’s safe and easy to wrap one’s head around, not to mention affordable due to that long loan term, and as such very popular.

This is why it’s heavily advertised and touted by most housing counselors and mortgage lenders alike.

With the 30-year, you can afford more house, which explains that 90% market share when it’s a home purchase.

Meanwhile, the 15-year fixed-rate market share is significantly higher on refinance mortgages because borrowers don’t want to restart the clock once they’ve already paid down their loan for a number of years.

Well, at least if you’re intent on paying off your mortgage at some point in this lifetime.

Despite the overwhelming popularity, there must be some drawbacks to the 30-year mortgage, right? Of course there are…

15-Year Mortgage Rates Are Lower

30 vs 15 mortgage rate chart

  • 15-year mortgage rates are always lower than 30-year rates
  • How much lower will depend on the spread
  • It fluctuates based on the economy and investor demand
  • May find that rates are 0.50% – 0.75% cheaper at any given time

First and foremost, you pay a premium for a 30-year mortgage vs. a 15-year mortgage in the form of a higher interest rate, even though both offer fixed rates.

Simply put, because you get more time to pay off the mortgage, there is a cost associated.

After all, mortgage lenders are agreeing to give you a fixed interest rate for double the amount of time, which is certainly a risk for them, especially if interest rates rise significantly during that period.

For that reason, you’ll find that 15-year mortgage rates cost quite a bit less than those on a 30-year loan product.

In fact, at the time this was written, mortgage rates on the 30-year fixed averaged 3.75% according to Freddie Mac, while the 15-year fixed stood at 3.22%.

That’s a difference of 0.53%, which is certainly very significant and should not be overlooked.

In general, you may find that 15-year mortgage rates are about 0.50% – 0.75% lower than 30-year fixed mortgage rates. But this spread can and will vary over time.

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I charted 15-year fixed mortgage rates since 2000 using Freddie Mac’s June average, as seen above.

Since that time, the lowest spread compared to the 30-year was 0.31% in 2007, and the highest spread was 0.88% in 2014.

In June of the year 2000, the 15-year mortgage rate averaged 7.99%, while the 30-year was a slightly higher 8.29%.

So the 15-year has been enjoying a wider spread lately, though that could narrow over time.

Monthly Payments Are Higher on 15-Year Mortgages

15-year fixed

  • Expect a mortgage payment that is 1.5X a comparable 30-year fixed
  • Not a bad deal considering loan is paid off in half the time
  • Just make sure you can afford it
  • Since there won’t be an option to make smaller payments

While the lower interest rate is certainly appealing, know that the 15-year fixed-rate mortgage comes with a higher monthly mortgage payment because you have 15 fewer years to pay it off.

If we consider a $200,000 loan amount, which isn’t necessarily that large, the monthly mortgage payment would be $476.19 higher on the 15-year mortgage because it’s paid off in half the amount of time.

So despite the lower interest rate on the 15-year fixed, the monthly payment is still significantly higher.

Take a look at the numbers below, using those Freddie Mac average mortgage rates:

30-year fixed payment: $926.23 (interest rate of 3.75%)
15-year fixed payment: $1,402.42 (interest rate of 3.22%)

Loan Type 30-Year Fixed 15-Year Fixed
Loan Amount $200,000 $200,000
Interest Rate 3.75% 3.22%
Monthly Payment $926.23 $1,402.42
Total Interest Paid $133,442.80 $52,435.60

This means loan amounts might be limited for those who opt for the shorter term.

Okay, so we know the monthly payment is a lot higher, but wait, and this is the biggie; you would pay $133,442.80 in interest on the 30-year mortgage over the full term, versus just $52,435.60 in interest on the 15-year mortgage!

That’s more than $80,000 in interest saved over the duration of the loan if you went with the 15-year fixed as opposed to the 30-year mortgage. Pretty substantial, eh.

You’d also build home equity a lot faster, as each monthly payment would allocate much more money to the principal loan balance as opposed to interest.

But there’s another snag with the 15-year fixed option.  It’s harder to qualify for because you’ll be required to make a much larger payment each month, meaning your DTI ratio might be too high as a result.

So for a lot of borrowers stretching to get into a home, the 15-year mortgage won’t even be an option.

Most Homeowners Hold Their Mortgage for Just 5-10 Years

  • Consider the fact that most homeowners only keep their mortgages for 5-10 years
  • So the projected savings of a 15-year fixed mortgage
  • May not actually be fully realized over the shorter term
  • But these borrowers will still whittle down their loan balance a lot faster in the meantime

Now obviously nobody wants to pay an additional $80,000 in interest, but who says you will?

Most homeowners don’t see their mortgages out to term, either because they refinance, prepay, or simply sell their property and move. So who knows if you’ll actually benefit long-term?

You may have a well-thought-out plan that falls to pieces in 2-3 years, and those larger monthly mortgage payments could come back to bite you if you don’t have adequate savings.

What if you need to move and your home has depreciated in value? Or what if you take a pay cut or lose your job?

Those larger mortgage payments will be more difficult, if not impossible, to manage each month.

And perhaps your money is better served elsewhere, such as in the stock market or tied up in another investment, one that’s more liquid, which earns a better return.

Make 15-Year Fixed Sized Payments on a 30-Year Mortgage

  • If you can’t afford the payments on a 15-year fixed home loan
  • Or simply don’t want to be locked into a shorter-term mortgage
  • You can make larger monthly payments voluntarily
  • That pay off your loan in half the time or close to it

Even if you’re determined to pay off your mortgage, you could go with a 30-year fixed and make larger payments each month, with the excess going toward the principal balance.

This flexibility would protect you in periods where money was tight, and still knock several years off your mortgage, assuming larger payments were made fairly regularly.

And there are always biweekly mortgage payments as well, which you may not even notice leaving your bank account.

It’s also possible to utilize both loan programs at different times in your life.

For example, you may start your mortgage journey with a 30-year loan, and later refinance your mortgage to a 15-year term to stay on track if your goal is to own your home free and clear.

In summary, mortgages are, ahem, a big deal, so make sure you compare plenty of scenarios and do lots of research (and math) before making a decision.

Most consumers don’t bother putting in much time for these mortgage basics, but planning now could mean far less headache and a lot more money in your bank account later.

Pros of 30-Year Fixed Mortgages

  • Lower monthly payment (more affordable)
  • Easier to qualify at a higher purchase price
  • Ability to buy “more house” with smaller payment
  • Can always make prepayments if wanted
  • Good for those looking to invest money elsewhere

Cons of 30-Year Fixed Mortgages

  • Higher interest rate
  • You pay a lot more interest
  • You build equity very slowly
  • If prices go down you could fall into an underwater quite easily
  • Harder to refinance with little equity
  • You won’t own your home outright for 30 years!

Pros of 15-Year Fixed Mortgages

  • Lower interest rate
  • Much less interest paid during loan term
  • Build home equity faster
  • Own your home free and clear in half the time
  • Good for those who are close to retirement and/or conservative investors

Cons of 15-Year Fixed Mortgages

  • Higher payment makes it harder to qualify
  • You may not be able to buy as much house
  • You may become house poor (all your money locked up in the house)
  • Could get a better return for your money elsewhere

Also see: 30-year fixed vs. ARM

Lock in a lower rate.


An Alternative to Paying Mortgage Points

If and when you take out a mortgage, you’ll be faced with an important choice. To pay or not pay mortgage points.

In short, those who pay points should hypothetically secure a lower interest rate than those who do not pay points, all else being equal.

That’s because mortgage points, at least the ones that are bona fide discount points, are just a form of prepaid interest.

So you’re essentially paying a portion of the interest on the underlying loan upfront, as opposed to monthly over the life of the loan term.

The caveat is that it is possible for a home buyer or refinancer to obtain a lower mortgage rate than another borrower without paying any points, assuming they shop around and use a mortgage lender with lower rates.

Now back to whether you should pay points or not, especially at a time when mortgage rates continue to hit new all-time lows.

Mortgage Rates Have Hit Record Lows 12 Times This Year

In an environment where mortgage rates are declining over a long period of time, paying mortgage points can be a mug’s game.

After all, you paid money upfront for a lower mortgage rate, only to find yourself back at the refinancing table. No bueno.

Indeed, many homeowners these days are asking the question, how soon can I refinance again?

Those who went the no cost refinance route have basically nothing to lose, other than maybe resetting the mortgage clock.

While those who paid several thousand dollars in closing costs, of which points made up the lion’s share, potentially have a lot to lose if they take out a new home loan right away.

Paying Points vs. Paying a Little Extra Monthly

$400,000 Loan Amount Pay Points Pay Extra Monthly
Upfront Cost of Points $4,000 $0
Mortgage Rate 2.5% 2.75%
Monthly Payment $1,580 $1,680
Extra Payment $0 $47
Loan Balance After 48 Months $362,324 $361,316
Total Paid After 48 Months $79,840 $80,640
Net Savings $208

Let’s consider a $400,000 loan amount where a borrower pays one discount point to obtain a rate of 2.5% on a 30-year fixed mortgage.

And an alternative where the homeowner decides not to pay any points and settles for a rate of 2.75% instead.

The homeowner who paid $4,000 upfront would enjoy a monthly payment of about $1,580 versus the higher payment of $1,633 for the no-points borrower.

That’s a difference of about $53 per month, which would take around four years to recoup when you consider the lower-rate mortgage reduces the outstanding principal balance faster.

Now if you didn’t want to pay that extra $4,000 at closing, you could simply go with the higher mortgage rate but still wind up with a similar mortgage balance after four years.

Simply pay $47 extra each month ($1,680 total) and your remaining loan balance would be around $361,316 after 48 months.

Meanwhile, the cheaper mortgage would be roughly $362,324 at that time with regular monthly payments.

That’s about a $1,000 difference for an extra $4,800 in payments over that time ($100 x 48). So the net cost is $3,800 over that time, slightly lower than the $4,000 paid upfront.

In the end, both borrowers are in a similar spot after four years, but the borrower who didn’t pay points had the option to refinance if rates moved even lower.

And they could pay extra each month to stay on track or just pay the minimum and invest the money elsewhere at hopefully a higher return.

Now, after those first four years are up, the math will start to benefit the homeowner who opted for the lower-rate mortgage in exchange for upfront points.

But how many homeowners are actually keeping their mortgage (or house) that long? Lately, not many.

In summary, this is just an inverse way of looking at buying mortgage points, which illustrates how those who don’t stick around for a long time can actually benefit from not paying points.

The counterargument is that rates are at record lows and will likely only go up from here, so if you can lock an even lower one in today, why not?

But we thought they had hit rock bottom years ago, only for them to defy the odds over and over again.

And as I mentioned, a borrower who actually takes the time to comparison shop could enjoy the best of both worlds.

[Watch out for low mortgage rates you have to pay for!]

Benefits of Not Paying Mortgage Points

  • You basically get flexibility versus a non-refundable upfront payment
  • Can refinance to a lower rate without worry at any time
  • Can sell your property whenever you want without leaving money on the table
  • Can still save on interest and reduce the loan term simply by paying extra each month
  • Gives you the option either way if you stay with the mortgage/property longer than planned
Lock in a lower rate.
About the Author: Colin Robertson

Before creating this blog, Colin worked as an account executive for a wholesale mortgage lender in Los Angeles. He has been writing passionately about mortgages for nearly 15 years.