Homeowner tips for financial success
As residential home buyers, we buy with financial awareness – how much home we can afford, plus, we take into account financial obligations and long term goals.
But, we also make our decision with a generous portion of emotion.
If we were strictly real estate investors, for example, we might buy the home that doesn’t look so hot, that we could fix up for under market value, and would appeal to a broad audience. We wouldn’t care if that home happens to be on a busy corner, doesn’t have a big yard, or isn’t near relatives, for example.
Our decision is influenced by emotional desires – permanency, wanting to be near friends or family, good schools, exciting neighborhoods, etc.
But, just because we don’t buy our homes like financial robots doesn’t mean that we can’t maximize our chances for financial success.
This is a subject dear to my heart, and what I wrote my book about, out now: Avoid the Money Pit, Turn Your Home Into a Financial Powerhouse.
In this series of article, I’m going to give you the building blocks of financial success for homeowners, which I call FACE. Each letter of FACE stands for a different building block.
We’ll start at the first letter, F, which stands for Financing.
None of us want to get a mortgage. We want to get a home. Getting a mortgage is a step in between. We want to get our mortgage as quickly as possible and not have to go through it again any time soon!
The mortgage industry makes it extraordinarily painful for us, due to tricky terms and marketing. Also, the fact is that a mortgage is a big loan, the biggest financial decision you’ll likely make, and it naturally requires a lot of paperwork, verification and qualification. Together, this creates a tedious, complicated and confusing process.
But, I’m going to cut through the red tape and confusion and give you the building blocks for success for your home financing.
It’s never too late to think about or fix your financing
Maybe you are looking to buy a home, or maybe you are 15 years into your mortgage. All of this information is relevant to think about, considering financing affects your equity and how you build the net worth in your home.
There are four main factors for financing: the down payment, the product, the interest rate, and refinancing. I will show you how they work together to ensure your financial success.
Your down payment – how much?
How much you money you put down for a down payment is important because your down payment does two things. One, it buffers you against market swings, and two, it affects the interest rate that you can get.
If the market drops 10% and you only have 3% of a down payment, you will be stuck in your home unless you can come up with the difference. There are a lot of pros and cons to putting less than 20% down, so it’s not necessarily true that you must put at least 20% down in order to have success, but your success with your home depends on you understanding the risks and benefits.
Why is down payment important to your financial success? Getting stuck in a home you can’t sell, or not being able to refinance are things that can deeply affect your financial outcome.
Your mortgage product – what’s the right fit?
Just over 50% of home buyers choose the 30 year fixed conventional mortgage. Surprised? The rest of home buyers choose a mortgage that has some mix of mortgage insurance, adjustable rate, or shorter term.
My point is, as a home buyer (and in refinancing), you have a lot of choice.
Because of mortgage products are confusing, home buyers and people refinancing often defer to their mortgage loan officer. This is a mistake. The loan officer’s job (and salary) depend on closing deals efficiently, and for this reason, they may limit your options.
It’s important for you to be truly independent in your decision making – each person has unique needs and goals.
How does your mortgage product effect your financial success? Simple. Your mortgage product determines your total cost and how you build equity by paying down your loan.
Your interest rate – what’s your strategy?
At the point in the process where you are finally locking in your interest rate, you’re likely sweating under the collar about whether you’re going to get a mortgage in time for your closing! Because of this, many people settle for what they are given.
To complicate matters, you have to produce so much documentation in order to even get a locked rate, that it feels simply unmanageable for home buyers and people refinancing to run parallel tracks with multiple loan officers in order to truly negotiate their rate.
But, there is a tried and true process you can use to extract the best deal once you’ve settled on a product without giving up or giving in.
Doing this will shave often 0.25% off of your interest rate, equating to $2,000 in savings over two years for a home that costs $200,000 at an interest rate of 4.00% and $10,000 in savings over two years for a home that costs $1,000,000 at 4.00%. Also, by reducing your interest rate, you’ll gain equity faster.
The financial benefit for negotiating your way to a lower interest rate is clear: lower overall costs and faster building of equity.
Your refinancing – what’s your future look like?
Throw out everything you’ve learned about refinancing.
Most of the information on refinancing comes from the mortgage industry. It’s critical that you pay attention now, because I am about to tell you has a huge impact on your financial success: it’s crucial that you do NOT focus on the monthly payment when you refinance. Doesn’t that usually run counter to everything you’ve been told?
Let me explain.
There are two reasons why mortgage payment is not a good measure of refinancing success. One reason is amortization, and the second is term (length of loan). And yes, they are related.
How to consider amortization in a refinancing
Because of the way mortgages amortize, in the beginning of your mortgage, a greater portion of your mortgage payment goes to interest than principal (paying down your loan) than at the end of your mortgage.
Let’s use the example of someone who has a $2,000 monthly payment. In the diagram below, amortization is illustrated by the red and blue triangles.
Here’s what a mortgage with a $2,000 monthly mortgage payment over time looks like. In the early years, more of your payment goes towards interest, and less goes to principal, due to amortization.
By year 5, more of your mortgage payment is going to principal than interest than in year 1, which is good, because principal payments pay back your loan and build equity while interest just goes to the bank, not benefiting you at all.
As an example, with a $2,000 mortgage payment, by year 5 $1,400 of your mortgage payment might be going just to interest, while $600 of it is going to paying back your loan and building equity.
Now, what happens if you want to refinance at year 5? If you were solely focused on monthly payment, you’d only care that your mortgage payment is lower. But when you refinance, you go back to the beginning of your amortization, where you are paying a greater proportion of interest than principal!
Because of this, you can lower your mortgage payment, get a lower interest rate and still pay more of your payment to interest and build less equity.
This is why you want to be really careful when refinancing. Monthly payment is a false indicator of a successful refinancing.
How to consider term (length of loan) in a refinancing
To make a refinance look good, loan officers will give you another 30 year mortgage, drawing out the time it takes to pay it down. This makes your monthly payment look great! But, stretching out the term has its drawbacks: more interest.
Let’s take the example above and refinance. We’ve paid down our loan for 5 years. In a refinance, we are taking the remaining loan balance and getting a new mortgage based on that same remaining loan amount.
In this example, we’re refinancing at year 5, taking our remaining loan balance and getting a new mortgage.
Let’s say we have $300,000 left to pay down on our mortgage. In the example above, we have 25 years left on our mortgage.
Now, since you are refinancing a smaller amount than your original mortgage (since you’ve paid some of it down), your monthly payment will be lower simply because you have less mortgage to pay back!
But, you will also start over from the beginning again in terms of your amortization, paying a greater proportion of your mortgage payment in interest than principal.
Taking another 30 year mortgage
You could really lower your mortgage payment by taking the remaining mortgage amount and stretching it out back to 30 years. But then you are starting over at the beginning of your amortization and stretching your loan out over many more years.
The combination of starting over at the beginning of amortization plus stretching your loan out to a longer term often means paying a greater proportion of interest to principal.
What does this mean? You pay more interest and build equity more slowly.
How to ensure a successful refinance
Refinancing is a balancing act of mortgage payment, interest and principal.
- Did the interest rate dip enough to offset amortization effects?
- Do you need to drop your payment due to hardship in order to keep your home?
- Is there a product you can switch to that can meet your needs better for the short or long term?
About one third of refinancing do not even benefit homeowners. This is because mortgage loan officers use monthly payment to justify refinancing, which can make a bad financial decision look good due to the factors we discussed above.
So how can you win at refinancing and set yourself up for success? You need the tools to independently evaluate refinancing options based on your unique situation and goals.
I wrote a book specifically to give you all the tools that you need to make home financing decisions that set you up for financial success from the time that you buy your home to the time that you sell it.
My goal is to make you fully independent, and allow you to make informed decisions so that you don’t waste time and money going down paths that don’t benefit you.
Read about and purchase the book, Avoid the Money Pit, Turn Your Home Into a Financial Powerhouse.