By Matthew Frankel, Selena Maranjian, and Dan Caplinger
A mortgage can be quite a drain on your long-term financial health, and it can ultimately cost more than you expect. For example, did you know that a $200,000 30-year mortgage at 4.5% interest will cost you almost $365,000 including all of the interest?
Obviously, you don't want to pay any more than absolutely necessary. With that in mind, our experts have three suggestions that could save you thousands of dollars on your mortgage.
One way to save a lot of money on your mortgage is to set up biweekly payments. Effectively, you'll make a full extra mortgage payment each year, which can cut years off your loan while saving you thousands in interest.
With a biweekly plan, instead of paying your entire mortgage payment once a month, you pay half of the standard amount on a specified date every two weeks. Over the course of a year, you'll make 26 half-payments, which are equivalent to 13 full payments.
You might be surprised by how much of a difference this can make. For example, let's say you have a $200,000 30-year mortgage at 4% interest, and your monthly payment (including taxes and insurance) is $1,200. By paying this mortgage on a biweekly basis, you'll pay the loan off almost five years early. More importantly, you'll pay $25,915 less in interest over the life of the loan.
Finally, a biweekly payment plan can be an effective budgeting tool, particularly if you're paid every two weeks. This way you can schedule your mortgage payments to coincide with your paychecks.
So, not only does a biweekly repayment make more sense for people who are paid biweekly, but it can enable you to pay your home off faster and save thousands of dollars.
Many people have taken advantage of low rates to refinance their mortgages, reducing their monthly payments and paying less in interest. But some have taken that strategy a step further: Rather than focusing solely on the monthly payment, they've instead dramatically shortened the period over which they'll repay their loans by refinancing with a 15-year mortgage.
In general, your monthly payment on a 15-year mortgage will be about 50% higher than a 30-year mortgage payment, assuming the same interest rate. However, you can often get a slightly lower rate on the 15-year mortgage. More importantly, the interest savings over time add up to a huge amount. On a $200,000 mortgage at 4.5%, for instance, you'll pay $90,000 less with a 15-year than with a 30-year over the course of the mortgage.
Finally, many homeowners refinance their mortgages after they've had them for eight to 10 years or more, and for them a 15-year mortgage term might actually have a maturity that is closer to the original payoff date of the existing mortgage. That might fit better with your financial plans for paying off your home. If you can afford it, a 15-year mortgage is worth a look.
If you plan to remain in your new home for a long time, you might want to lower the interest rate on your mortgage by paying "points" to the lender.
A point refers to 1% of your loan's total value. So if you use a mortgage to borrow $200,000 to buy a new home, one point would be $2,000, two points would be $4,000, and so on. Some lenders will quote their loan origination fees in points, charging you, say, a point or two for that. But very often, "points" in the mortgage world refer to an optional extra payment through which you essentially buy a lower interest rate.
The longer you hold that mortgage, the more valuable this can be to you. For an idea of how points work, consider this example from the Bank of America (NYSE: BAC ) website for a $200,000 loan in which a point would be $2,000. If you pay no points, your interest rate might be 5.125%; if you pay one point, it could fall to 4.875%, while two points could drop it to 4.75%. If you dropped it to 4.75%, it would take 87.5 months (7.3 years) to break even, saving you enough in interest to cover the cost of the points. Over the life of the loan, you'd save $12,445.
The points you pay to lower your interest rate are generally tax-deductible, too, as they're a form of prepaid interest. Don't automatically choose to pay points, though. If you might not be in the home long, you'll lose money. Consider, too, whether you might have better uses for the money. But for many people, paying points is a smart move.
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