Saving Money Without Too Much Pain

A few years back, it became popular to reduce the interest expense of a home mortgage by dividing the monthly payment in half and making two payments each month. This also helped those on a budget align the timing of their expenses and with the timing of their paychecks. While I don’t hear about this approach as often these days, it’s still a good idea, so I thought I’d explain how it works.

Intuitively, you must wonder: if I pay the same amount of money each month overall, but just split the payment into two installments, how can that save me thousands of dollars over the life of the loan? It basically comes down this: you’re making one additional payment each year.

If you have a 30-year loan of $100,000 with a 4 -percent interest rate, your regular monthly payment would be about $480. At the end of 30 years if you make 12 payments per year, you’ll end up paying back the $100,000 loan plus another $72,000 in interest. If instead, you pay $240 every two weeks, you’re paying the equivalent of $520 per month because of the timing of the payments adding one full payment per year. The higher payment means you’ll pay the loan off sooner—in this case, four years sooner for a net savings of  $11,000 in interest over the life of the loan. As the interest rate goes up the savings increase geometrically – at 6 percent (a 50 – percent rate increase) you save more than $24,000 (a 127 – percent increase).

For most conventional home loans, you can pay up to 20 percent of the loan value each year without pre-payment penalties. This allows you to save interest over the life of the loan, but does not obligate you to make the higher payments. Of course, it’s a double-edged sword: if more immediate spending options lure you away from your long-term financial goal of paying your mortgage off early, no one is there to force you to stick to your original plan.

Another way to achieve a similar result (that forces you to make the higher payments) is to start with a 15-year loan rather than a 30-year loan. This has two advantages: you pay off the loan more quickly and the loan can usually be obtained for ¼-percent to ½-percent lower interest rate.

Whether you choose this approach should depend on alternative uses for your money. If the higher mortgage payments make it impossible to send junior to college or replace your 15-year-old clunker, this may not be a good option for you right now.

There is a way to get the best of both worlds: take the 15-year mortgage (if you can pay more in the short run), and as equity in the property increases through the down payment, appreciation of the property or amortization of the loan, talk to your local bank about a home equity line of credit (HELOC).

A HELOC allows you to put more money toward your mortgage while still maintaining your access to cash if you need it. All of this assumes you’ve maxed out other investments with higher returns than your mortgage, like maximum contributions to your retirement account, for example. The HELOC option is a good idea if your budget will allow a higher payment. But do make sure you’re wise about it. If you have a rotating credit card balance getting charged at 22 percent, pay that off first. That interest is much higher than a home loan and isn’t tax deductible.

If you’re in the process of buying a house, your realtor can explain the ins and outs of a 15-year versus a 30-year loan. Don’t hesitate to ask!

If you have questions about real estate or property management, feel free to contact me at rselzer@selzerrealty.com or visit our website at www.realtyworldselzer.com. If I use your suggestion in a column, I’ll send you’re a $5.00 gift card to Schat’s Bakery. If you’d like to read previous articles, visit my blog at www.richardselzer.com. Dick Selzer is a real estate broker who has been in the business for more than 35 years.

What’s It All Mean? Real Estate Definitions

Real estate, like many industries, has a whole language of terms and definitions that make sense to those of us who live and breathe real estate, but that can leave homeowners in the dark. So I thought I’d shed a little light on the subject.

Licensed Real Estate Agent – someone licensed by the California Bureau of Real Estate to transact otherwise restricted business transactions, including the listing and selling of real estate, under the supervision of a broker

Realtor– licensed real estate professional who is a member of the National Association of Realtors, which requires adherence to a strict code of ethics

Licensed Real Estate Broker – someone licensed by the California Bureau of Real Estate to transact otherwise restricted business transactions, including the listing and selling of real estate and the brokering of real estate loans.

Single Family 1-4 – this is how we refer to the category of real estate that includes single-family homes, duplexes (2 living units), triplexes (3 living units), and four-plexes (you guessed it—4 living units)

Financial Institution – in this context, an organization in the business of making loans secured by real estate

Underwriting – process of determining whether to make a loan whereby a lender or his representative reviews a property and all of the borrower’s qualifications to purchase it

Conventional Loan an institutional loan usually secured by a single family 1-4

Conforming Loan usually a loan that meets specific underwriting requirements and includes a minimum of 20 percent down and (in this area) a maximum value of $417,000

Owner-Occupied – a single family 1-4 owner will occupy one of the units or anticipates occupying it within 12 months. This is a requirement for most loans.

Primary Residence – the owner-occupied unit where the owner spends 50 percent plus one day each year. Single-family, owner-occupied, primary residences typically secure the best loan terms

USDA, FHA, VA, CalVet – these are large government loan programs. The United States Department of Agriculture offers loans to families in rural areas who don’t make too much money; the Federal Housing Authority offers limited loans to those with good credit; the Veteran’s Administration offers loans to U.S. veterans, and CalVet offers loans to vets who want to purchase a home in California.

GSEs – Government-Sponsored Entities are institutions that buy loans from loan originators on the secondary market with the goal of providing lower housing costs and better access to financing. The big players are referred to as Fannie Mae, Freddie Mac and Ginnie Mae. They are actually the Federal National Mortgage Association (FNMA), the Federal Home Loan Mortgage Association (FHLMA), and the Government National Mortgage Association (GNMA)—which is actually part of the US Department of Housing and Urban Development.

Pre-qualified a loan representative has given you the likelihood of loan approval based on information you’ve supplied.

Pre-approved – a loan representative has reviewed documentation, verified income and employment, confirmed the source of funds for the down payment and closing costs, reviewed credit, and made all determinations to arrive at a monthly payment for which you qualify; leaving only the property and its value in question.

Debt-to-Income Ratio – compares overall debt to income. Front-end ratio: the ultimate loan payment divided by net income. Back-end ratio: all debt expense (car loans, credit cards, any other recurring debt) divided by income. A lender will use both to determine the loan amount you qualify for.

Escrow – neutral, third-party depository where the buyer, seller and lender place money and/or appropriate executed documents. When all escrow conditions are met, the escrow holder (usually the title company) will record the documents and distribute them and the funds to the appropriate parties.

Funded – usually means the lender has deposited net loan proceeds into the escrow account.

If you have questions about real estate or property management, feel free to contact me at rselzer@selzerrealty.com or visit our website at www.realtyworldselzer.com.  If you’d like to read previous articles, visit my blog at www.richardselzer.com. Dick Selzer is a real estate broker who has been in the business for more than 35 years.