submitted by jwithrow.
A stable housing situation is a vital part of a self-sufficient financial plan. While home-ownership is not something that should be rushed into, we would suggest that it is advantageous to purchase a home and begin to pay down the principal balance once you are settled into a community and intend to stick around for an extended period of time. Owning a home will involve repair expenses that could be avoided by renting, but the opportunity to one day be free of a monthly housing payment is probably worth the cost of periodic home repairs.
In order to purchase a home, most of us need to obtain mortgage financing. There are a number of different mortgage types available for consumers, but a fixed rate conventional loan is by far the best option for someone who is buying a home with the intent to occupy it for the foreseeable future. As such, this article will be geared towards someone who intends to buy a home for the long haul. While the ‘long haul’ time frame is dependent upon the perspective of the home buyer, please see our thoughts on the matter here.
Unlike the other options, a conventional mortgage will allow you the choice to either escrow your homeowners insurance and property taxes as part of the monthly payment or to pay your homeowners insurance and property taxes separately. A conventional loan will also allow you to avoid private mortgage insurance (PMI) if you are able to pay 20% down up front. PMI is simply insurance that covers the lender in case the borrower defaults and it is paid by the borrower as part of the monthly payment. When obtaining a mortgage, avoiding PMI should be a top priority as it is nothing more than wasted money from the borrower’s perspective.
If at all possible, you should plan to pay 20% down when purchasing a home to avoid PMI and lock in the best terms. Some lenders will allow borrowers to also pay 10% down up front in exchange for a reduced PMI payment. If you are unable to pay 20% down initially but feel like you have the opportunity to get a great deal on a home purchase then most lenders will release the PMI requirement once you have paid the mortgage down to 80% loan-to-value (LTV) – be sure to ask about this up front. The loan-to-value ratio is simply how much you owe on your mortgage as a percentage of the home’s appraised value.
When shopping for a mortgage it can be difficult to directly compare mortgage quotes from different lenders as each lender structures closing costs differently. One lender may offer a slightly better rate but charge higher closing costs up front while another may offer a higher rate in exchange for lower closing costs. You can also choose to pay more up front to reduce the rate or vice versa when originating a mortgage. It is advisable to have a conservative idea as to how quickly you intend to pay the mortgage off before shopping for one. This way you can analyze how much you will be paying in interest and fees over the life of the loan so that you can determine which option would make the most financial sense for you.
When shopping around for a mortgage, we would recommend contacting several different lenders and asking them for an initial quote listing the interest rate and estimated closing costs. Advise them that you are shopping for a mortgage and that you will get back to them if their offer is the best. The interest rate will change every day so you will need to get the quotes on the same day that you intend to lock in an offer. Do not feel like you need to rush into a commitment, however, as you can always ask a lender to send you another quote at a later date if you are not ready to move forward initially.
Once you have several quotes in front of you, calculate the amount of interest paid over the period of time in which you intend to have the mortgage for each offer. Next, add the total interest paid to the estimated closing costs for each quote to determine the total cost of financing over the life of the loan. Whichever lender comes out with the lowest cost of financing is probably your best deal but keep in mind that each lender may estimate title insurance and attorney fees differently and that these costs will depend on the title company or attorney used for closing. It may even make sense to exclude the title insurance costs and attorney fees from your analysis if you intend to use your own title insurance company or attorney rather than the lender’s.
Mainstream mortgage advice suggests that you should lock in the lowest monthly payment possible over a thirty year period but this is not always the best way to go. Mainstream advice assumes that you will only make minimum payments and that you have no interest in paying the loan off early. We would suggest that it should absolutely be your intention to pay the mortgage off early as the idea is to minimize the amount of interest paid over the life of the loan. If you are confident that your income is stable then it may make more sense to go with a fifteen year mortgage in order to secure a better rate in exchange for a higher monthly payment. Also, be sure to play around with amortization calculators online to see how much interest you can save by paying extra on the mortgage each month.
Once you are a homeowner, be careful not to get caught up in the temptation to use your house like a piggy bank as was common during the housing bubble of the 2000’s. People love to talk about building equity in their home but this is a false premise. The term equity refers to the difference between what you owe on the mortgage and what the appraised value of the home is. Mainstream finance suggests that this equity is an asset. We suggest that it is an illusion (ever heard of anyone getting their ‘equity’ after the mortgage has been paid off?). Only the market can determine what the true value of your home is. If you do not have a buyer lined up to buy your home then you do not know exactly what your home is worth. A lender would be quick to issue a home equity loan based on the illusion of equity but this would only serve to increase the amount of interest you are paying each month.
Rather than thinking in terms of building equity, we think that it is far more wise to focus on paying off the mortgage as quickly as possible without sacrificing other opportunities. Just imagine the extra cash flow that would be available to you if you no longer had to make a mortgage payment.
Eliminating your monthly housing expense will greatly increase your resiliency and self-sufficiency and that should be your ultimate goal when shopping for a mortgage in our humble opinion.