Homeowner tips for financial success, Part 1
Here, I’m distilling my best tips, based on years of research and filling you in on actionable things you can do to increase your financial success through home ownership. It’s what I wrote a book about, coming out soon: How to win at homeownership while avoiding the traps. Welcome to Part 1!
As home buyers, we buy with financial awareness – how much home we can afford, considering our financial obligations and long term goals. We also make our decision with a generous portion of emotion. 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.
I call the building blocks for financial success for homeowners FACE. Each letter of FACE stands for a different building block. We’ll start at the first letter, F, which stands for Financing.
No one wants to get a mortgage. We want to get a home. Getting a mortgage is a necessary step in between. The mortgage industry makes it seem painful, due to tricky terms and marketing. A mortgage is a big loan, and requires a lot of paperwork, verification and qualification. Together, this creates a long and confusing process.
Let’s cut through the confusion.
It’s never too late to fix your financing
Whether you are buying a new home or 15 years into your mortgage, there are four main factors for a successful financing: down payment amount (your equity), the product, the interest rate, and how you refinance.
Building block #1: down payment (your first equity). How much?
The amount of your down payment affects three things: 1) it buffers you against market swings, 2) it affects the interest rate that you can get, and 3) it affects whether you can refinance.
To the first point, 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 understanding the risks and benefits. To refinance, you usually need at least 20% equity in your home, too.
Why is down payment important to your financial success? Getting stuck in a home that you can’t sell, or, not being able to refinance are things that can deeply affect your financial outcome. Talk about frustrating!
Building block #2: Type of mortgage. Do you have the right fit?
Just over 50% of home buyers choose a 30-year fixed conventional mortgage. The rest of home buyers choose a mortgage that has some mix of mortgage insurance, adjustable rate, or a shorter term. Sometimes the mix of other fees isn’t clear to home buyers and home owners. The important thing? You have a lot of choice.
Because of confusion, though, home buyers and people refinancing often rely on their mortgage loan officer to guide them. This can be a mistake. The loan officer’s job (and salary) depend on closing deals efficiently, and for this reason, they may limit your options. Think of it as a sales funnel – if you introduce a lot of options, it takes longer for decisions to be made, and longer to close a deal. It’s important for you to be truly independent in your decision making – each person has unique needs and goals.
Your mortgage product determines your total cost and how you build equity by paying down your loan. That plays a huge part in your financial success!
Building block #3: 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 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 and $10,000 in savings over two years for a home that costs $1,000,000 at today’s interest rates. Also, by reducing your interest rate, you’ll gain equity faster, as less of your payment will go to interest and more to paying down the principal.
The financial benefit for negotiating your way to a lower interest rate is clear: lower overall costs and faster building of equity.
Building block #4: Refinancing – what effect will it really have on your finances?
There are two really important things to know about refinancing, 1) one-third of refinancings don’t even benefit home owners and 2) the way that you refinance has a huge effect on your long-term financial success as a homeowner.
Below, I’m going to break it down for you on the specifics of these two points, but if you want to take anything away from this, it’s this: don’t refinance on monthly payment alone.
There are two reasons why mortgage payment is not a good measure of refinancing success, 1) you pay more interest in the beginning of a mortgage (due to amortization) and monthly savings won’t reflect this, and 2) refinancing can stretch a mortgage out to a longer term, and monthly payment won’t reflect this either.
There is a lot of research on how refinancing can really affect your financial success in the long term, so you want to be careful with it.
Your goal: weigh the cost savings (total monthly payment) with building of equity more slowly. In the beginning of a mortgage, a greater portion of your mortgage payment goes to interest than principal (paying down your loan) than at the end of your mortgage. I can explain this best in the diagrams below.
Let’s use the example of someone who has a $2,000 monthly payment for a 30-year fixed mortgage:
But by year 5 (below), more of your mortgage payment is going to principal than interest compared to in year 1. And, principal payments pay back your loan and build equity while interest just goes to the bank, not benefiting you at all.
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 can be a false indicator of a successful refinancing.
Choose the length!
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 it’s drawbacks: more interest.
If you paid your 30 year mortgage down for 5 years, that means you have 25 years left:
If you refinance into another 30 year mortgage, your total length of mortgage will be 5 + 30 = 35. And, remember, the longer your mortgage, the more interest you’ll pay.
Good news! You can choose the length of mortgage you refinance into. How about a 25 year mortgage? What about a 17 year mortgage? Being able to select the number of years of your new mortgage can offset potential loss of equity plus deliver a pocket-friendly monthly payment.
WIN AT REFINANCING! AND MORE.
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, or meet other financial obligations?
- Is there a product you can switch to that can meet your needs better for the short or long term?
What if someone could basically do it for you, with expert knowledge and no biases? I’m launching a book in the fall that gives you simple and effective tools that you need to make decisions that set you up for financial success from the time that you buy your home to the time that you sell it. It eliminates all of the guesswork.
Put your email in below to get notified when my book launches, and get 20% off as my gift to you.