Note from David: When I got serious about financial improvement, I knew I wasn’t going to be able to totally eliminate dining out, Starbucks, and other indulgences like every personal finance book told me to. (Some people can; I just liked them too much.) Instead, I chose to a) earn more money and b) drastically reduce my biggest monthly expense—my housing. I ditched my apartment, moved in with roommates, and cut my rent IN HALF.
You can easily save more money on the big stuff (your home and your car) than on all the little stuff combined…you just have to be willing to make the leap. You can make a big dent in your budget by downsizing your crib OR—if you’re a homeowner—you can save TENS OF THOUSANDS of extra dollars over the long-run by taking a long, hard look at your mortgage.
How to Save Big Money on Mortgage Interest
Despite the recent downtrodden real estate market, buying a home is typically a good long-term investment…especially if you get in during a market dip. Just how much you can gain from owning your home depends on a number factors, but two big ones are:
- When you buy your home. (Real estate is naturally cyclical.)
- How much you pay in interest over the life of your loan.
For example, if you hold a $300k mortgage at five percent over 30 years, you’ll end up paying $279k in interest. (And let’s not forget, 20 years ago homeowners paid mortgage rates of 15 percent or more!)
So…if I can show you some ways to shrink that figure, wouldn’t you be interested?
GET A SHORTER LOAN
If you can afford the monthly payments, getting a home loan with a shorter term rather than the traditional 30 years can is the financially savvy way to go. In fact, there’s mounting evidence that 20-year fixed rate mortgages may gradually become more popular than 30-year mortgages.
Not only do they save homeowners a ton of interest, but 20-year mortgages are safer for investors (and yes, we should care, because bad mortgages led us into this lousy economy in the first place).
That $300k loan at five percent would cost $1,610 a month. The same loan amount with a 20-year term would have a monthly payment of $1,980. Amortized over 15 years, it would cost $2,372. Some lenders even offer 10-year terms on home loans. Here’s a table showing the same $300k loan with different interest rates:
If you can afford to make larger payments each month, you’ll end up saving yourself anywhere from 10 to 15 years of interest, meaning thousands of dollars that would have been wasted are going back in your pocket.
Another important point is that the shorter the term of the loan, the lower the interest rate typically is, since the lenders plan on getting their money back faster and there is slightly less risk involved in the loan.
It’s David Again: When my wife and I bought a home last year, I convinced her to go with a 20-year loan. The monthly payment difference was about $250 for an interest savings of over $60,000. Do we miss that $250 every month? Sure. But is it worth it to save 60 grand? Hell yes!
PAY YOUR LOAN FASTER
Another way to pay less interest on your mortgage is to simply make payments more frequently. If you’ve got a 30-year mortgage you want to stick with, this is your strategy.
Many lenders allow you to pay your mortgage bi-weekly instead of monthly. Making bi-weekly mortgage payments can help you to pay off your mortgage between six and eight years earlier than you would with monthly payments. And that means you’ll save a huge chunk of cash on interest.
On that $300,000 loan at five percent, you’d be looking at a bi-weekly payment of $805 instead of $1,610 monthly. And over the life of the loan, you’d save $51,493 by paying your mortgage every other week instead of monthly.
Keep in mind that if you get paid every other week, making bi-weekly payments is almost a no-brainer, since you can have your mortgage payment transferred automatically on payday…
A final caution. Unfortunately, making bi-weekly mortgage payments isn’t always free. Some lenders charge a set-up fee, around $300 to $400, just for the privilege of making more frequent payments. Although unusual, you’ll also want to ensure your mortgage does not include a pre-payment penalty.
MAKE LUMP SUM PAYMENTS
If you can’t afford to make bi-weekly payments on a regular basis, you can still reduce the total amount of interest you’ll pay on your mortgage by making occasional extra payments.
(Think tax refunds, small inheritances, or Christmas bonuses.)
The occasional lump sum payment may not help you pay off the mortgage ten years early, but it will save you money on interest over time, and every little bit helps.
If you have equity in your house and you’re paying more than the current interest rates, consider refinancing to lower your interest rate. (Check the latest mortgage rates in your area). As an example, if you refinance from five percent to 4.25 percent on that 30-year, $300k mortgage, your monthly payment will drop $134, from $1,610 to $1,476. How much interest you will save (if any at all) depends on several factors, including:
- How long you held your old mortgage.
- How much equity you have in your home.
- The term of the refinance mortgage.
- The closing costs on the refinance.
The best way to use refinancing to save on interest is to refinance into a new mortgage that:
- Has a lower interest rate AND
- A shorter term.
For example, if you’ve held a 30-year mortgage for five years at six percent, you could probably get a significant interest savings by refinancing to a 20-year mortgage at 4.75 percent (perhaps for a similar monthly payment).
- Quick Tool: Get no-obligation refinance quotes online.
Determining whether or not refinancing is a good decision can be tricky. There’s no substitute for carefully going over actual numbers you get from a loan officer, but you can play with refinancing scenarios using BankRate’s refinance calculator to get a sense of whether refinancing makes sense for you. In a refinance, you want to consider three things:
- The upfront costs (i.e., how much cash do you need now?)
- The monthly payment.
- The long-term interest savings.
David again, one last time: More than ever, having really awesome credit is critical to successfully refinancing. (And getting a new mortgage, if you haven’t bought yet.) Check your credit score and, if it’s not in the mid-700s take four to six months to repair your own credit before applying for a home loan. We’re talking about saving money on interest here, and the single best way to do that is to have the best credit possible when you apply.
When it comes to your home, small changes can result in HUGE savings over the long run. And there’s never a better time to act than right NOW. Good luck!
What about you? Have you taken steps to reduce the amount of interest you’ll pay on your mortgage? What did you do? And how much do you think you’ll save?