Borrowers should be knowledgeable about mortgage rates, loan programs and various options available to reduce the life of their loans thus to significantly save thousand of dollars in interest payments. There is no doubt that low fixed rate loans are far more secure and beneficial versus volatile loan programs such as Adjustable mortgages, Pay-Options etc. It’s recommended that initially based on affordability factor, borrowers should be concerned in choosing the type and terms of mortgage loans with lowest payment obligation to avoid unanticipated financial difficulties such as late-payments, notice of defaults, foreclosures etc. Making regular payments on time would be a big relief for homeowners while improving their credit ratings. Subsequently, borrowers should be very much concerned to plan affordable ways to reduce the life of their loan thus to achieve significant savings. It should be noted that all loan programs including those with pre-pay penalty, allow borrowers to make excessive payments at any time toward principal reduction.
The most popular method to reduce life of loans is the fixed rate “Bi-Weekly” (BW) payment. This method requires borrowers to make a total of 26 BW payments during each calendar year, which results in making one extra payment per year. The excessive payments over the years will generate significant interest savings as explained under Bi-Weekly mortgage. Other options are the fixed rate loans with shorter terms such as 25, 20 and 15 years which can generate significant savings in interest as explained below under the chart.
The purpose of this article is to review these options for fixed rate conventional loans as well as to demonstrate that there are other simpler, safer and affordable options to achieve significant savings while committed to lowest monthly payment obligation (LMPO).
30 years fixed rate mortgages
The low fixed rate mortgage for 30 years is one of the most popular and affordable loan programs because of lower fixed payments during the life of loans. For example, lets assume we have a conventional loan for $350,000, fixed for 30 years @ 6.50% interest rate. The fixed monthly payment would be $2,214 during the life of loan. Lets consider the $2,214 as the LMPO. The only problem with the fixed rate 30 years loans is the slow pace of principal reduction (PR) during the early years. Although PR will gradually increase as loan ages, nevertheless borrowers should always be concerned with how to accelerate the principal pay-off thus to significantly save interest while increasing their equity.
Bi-weekly mortgage payments
This method requires borrowers to make a mortgage payment every 14 days, which is referred to as Bi-Weekly (BW). The BW payments will not improve the interest rate. It only accelerates the principal reduction by splitting regular monthly payments into BW. For example, the BW payments for $350,000 fixed for 30 years @ 6.50%, would be $1,106 every two weeks. Hence because of the BW payments, total interest saving during the life of loan would be about $104,166 versus the same loan amortized in 30 years.
The BW payments are an effective way to make significant savings. However the problem is the commitment to make BW payments. Life is full of surprises and unanticipated events such as illness, accidents, lay-offs etc. that could lead to financial hardship to keep up with the BW payments.
Our Recommendation
American Financial Services has been working with borrowers to help them save thousands of dollars since 1989. In our example, our recommendation to avoid the commitment to Bi-Weekly payements would be to make the above-mentioned $2,214 plus voluntarily excessive payments of $184.50. Therefore total payments would be $2,398.50. This will result in total interest savings of approximately $103,100 due to the extra payment of $184.50 per month. The result is same as Bi-Weekly payments except for $1,066. However, notice that payments are made on monthly basis rather than Bi-Weekly. Should borrower face any unanticipated difficulty, the excessive payments can be discontinued for a while and then resumed. We know life can throw unexpected expenses at you, that is why our loan consultants works closely to find a solution that meets your needs. Our loan consultants can help you with your individual financial needs, simply contact us for more detailed solutions. Next we will discuss the huge saving borrowers can obtian with refinancing and short term mortages.
Shorter term mortgages 25, 20, 15 years
Many borrowers choose shorter terms fixed rate mortgages to quickly pay-off their loans thus to achieve significant savings in interest. Shorter terms require higher monthly payments during the life of loan. Obviously, if borrowers can financially handle the higher payments for duration of the loans, then they should select the appropriate short-term mortgage to pay-off their loans earlier while increasing their equity.
It’s interesting to review the following chart which demonstrate the interest savings of short-term mortgages versus the 30 years fixed rate loan. For realistic comparison, all rates are the current interest rates at par value effective 08/10/07 for a conventional loan of $350,000: -
N O T E: Blue bars show the total interest payable during the life of each term/rate
Borrowers should be absolutely sure that they could make the higher mortgage payments as shown above. This is a long-term commitment plus the ever-increasing property tax, insurance, HOA and other fees.
On the other hand, assume that a borrower chooses a 30 years fixed rate mortgage for which payment would be $2,155. However, this borrower also decides to make voluntary excessive payment of $775 for a total payment of $2,930 per month. This will result in paying off the loan in 15.6 years (187 months), versus the original term of 30 years. Total savings in interest versus the 30 years term would be approximately $227,743. The difference versus the 15 years term would be approximately $21,600. This difference is due to lower interest rates applicable to 15 years fixed rate mortgages. This difference can be made up by couple of lump sum payments during the life of loan. The same scenario and savings will be applicable to other shorter terms of 20 or 25 years.
Based on above recommendation, legally and financially, the borrower is committed only to paying $2,155 and not the $2,930. Should this borrower faces financial difficulties, he or she can always reduce or discontinue the excessive payments of $775 for a while and then resume the additional payment as well as make up for any shortfalls.
The question arises as to which way is more realistic and safer? Do borrowers have to commit to higher payments for duration of the loan? It’s an important choice for borrowers. Realistically, it’s a matter of Income, budgeting and discipline for borrowers.
Other recommendations
Lets assume we have a fixed 30 years loan $350,000 @ 6.25%, for which the regular monthly payments are $2,155. However, the borrower has been making voluntary excessive payments of $185 per month. After 7 years, the principal balance would be $295,844. During the 7 years, borrower has received gift money, tax refund or inheritance money. Lets say that lump sum payments amounting to $10,344 were made toward principal reduction. Therefore the loan balance at end of 7th year is $285,500. Consider that interest rate at the end of 7th year have dropped to 5.750% for a 20 years fixed mortgage.
Knowledgeable borrowers should take advantage of market conditions by refinancing the loan balance $285,000, say for a 20 years fixed rate @5.750% for which the regular payments would be $2,001 per month. Notice that payment from $2,155 dropped to $2,001 (minus $154). Nevertheless the borrower continues to make the previous payments of $2,155. This will result in paying off the loan in 15.32 years or 184 months or a total interest savings approximately $135,920 versus the original term of 30 years while reducing the pay-off period by 8 or 9 years.
This example clearly demonstrates that making regular and/or lump sum excessive payments and refinancing at the right time, could save hundreds of thousands of dollars. Call it creative financing. Implementing various factors at right time could lead to significant saving. Every regular or lump sum voluntary excessive payment, no matter how small, will save thousand of $$$ over years.
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