If you’re like most homeowners, your mortgage payment looms on the calendar as the single largest expense each month. Pruning that payment can add cash to your household budget — every month. As Ben Franklin would say, “a penny saved is a penny earned.” Let’s see how you can save the most, and make Ben proud.
The trick to lowering your mortgage payment is to start by reviewing what is actually included in the bill. Many people don’t realize that a mortgage bill is often a combination of several separate expenses. By breaking it down, you can explore any flexibility you might have with each of its component parts. Do this and you’ll discover compelling strategies to trim your expenses and plan for the future. Here are seven of those strategies.
1) Know Your Numbers
Refinancing gives you an opportunity for a better deal that might extend the term or bring down the interest rate. While mortgage loans are long-term commitments, refinancing lets you take advantage of market changes to find a loan that better fits your current circumstances. Refinancing pays off the old loan and establishes new terms, including the interest rate.
If the value of your home has increased, you can directly benefit through the Loan-to-Value (LTV) ratio used to determine the terms for the loan. When you first purchased the home, your down payment established the equity you have in the house. With 10% down, your loan covers the other 90% of the home’s purchase price.
As you make loan payments, some of your payment goes toward the principal, or the amount actually borrowed. The rest of your payment goes toward the interest accruing on your loan. As you pay down the principal, you are contributing to the equity you have in your home. And as the home value goes up, that added value also becomes part of your equity — often at a much faster rate.
The credit score you’ve earned by consistently paying your mortgage and other bills on time also enables you to take advantage of even further options. It makes you an appealing customer and financial institutions will compete for your business.
Looking for a deeper understanding of refinancing? We’ve demystified how refinancing works.
2) Get Rid of MI
If you have an FHA loan, or a conventional loan, but didn’t have the cash for a 20% down payment when you bought your home, then your loan payment probably includes Mortgage Insurance (MI).
MI protects the lender in case you’re unable to repay the loan. If your circumstances have changed, however, since securing the original mortgage, it may no longer be required once you refinance.
While MI is always required on loans from the Federal Housing Administration (FHA), once your equity reaches 20% or higher, you could then qualify for a conventional loan to eliminate a lender’s MI requirements. As described earlier, refinancing allows you to revisit the LTV ratio to take advantage of the growth in your equity from two key factors:
- The amount of principal paid
- Your home’s rising market value
An original loan for 90% of the home value would have required MI. But should you decide to refinance, any increased market value since that original purchase will be taken into account. If a home appraisal can show that the property has appreciated substantially, the same loan amount now might be at or below 80% of the market value — thus eliminating the need for MI.
3) Redo Your Tax Assessment
As you dig into the components of your monthly bill, it may also include contributions toward an escrow account that covers property tax payments.
In markets where property values are volatile or declining, it may be worthwhile to ask the county assessor to reassess your property value for tax purposes. Lower values will mean lower tax payments — regardless of whether they’re paid directly or through an escrow account with your lender.
Want to learn more? Check out our article on how refinancing affects real estate taxes.
4) Lower your Homeowners Insurance Payment
Like property tax payments, homeowners insurance premiums can be paid through the escrow account on your mortgage loan as well. It may require a bit of research, but you should periodically review your coverage and provider.
Insurance premiums are affected not only by replacement values but also by factors like deductibles and discounts. In a competitive market, you want to be sure you have the right level of coverage at a competitive rate.
You may find a provider offers discounts if you choose a higher deductible or combine home and auto plans, for example. In certain areas of the country, providers also offer discounts for seismic retrofits and fire mitigation. These kinds of programs not only help protect your home, but they can also save you money.
5) Let the Government Help
As a homeowner, you contribute to your community in ways that local and federal institutions want to support. The federal government has several loan modification programs that, depending on your circumstances, can help you bring down your monthly costs.
Here are a few:
- Veterans Administration (VA) loans are available exclusively to U.S. military veterans and their families and are guaranteed by the Veteran’s Administration. If you currently have a VA-backed loan, an Interest Rate Reduction Refinance Loan (IRRRL) may help you lower your monthly payments*.
- Federal Housing Administration (FHA) loans, designed for those with lower credit scores and/or without the means for a large down payment, offer an additional benefit on refinancing. Homeowners with an existing FHA mortgage that closed more than six months prior may be eligible for Streamline Refinancing that doesn’t require extensive documentation or home appraisals.
- U.S. Department of Agriculture (USDA) loans also offer favorable programs for borrowers to refinance. The Simplified Assist Program reduces documentation requirements on refinancing for borrowers who have been current on their loans for 12 months. Like FHA Streamline refinancing, new appraisals are not required unless a borrower is receiving a subsidy on the loan.
- Hardest Hit Fund (HHF), a program introduced following the subprime mortgage crisis, is still available in states hit hardest by the crisis. The program works with loan servicers to modify the payments of qualified borrowers.
6) Recast Your Loan
Another approach to lowering your monthly expense is to request that your loan servicer recast your loan, which is when you can ask for a recalculation of your mortgage payments after making a large, one-time payment.
Should circumstances allow you to make a large sum of money available — for example, from an inheritance — you can make a lump-sum payment toward your principal balance. For a fee (in most cases), your lender will then reamortize your loan based on the new, lower balance, thus lowering your monthly payments.
7) Start with a Low Payment
At the end of the day, the fastest way to lower your payment is to start with the right loan. Understanding the components that affect the cost of mortgages helps you focus on the factors that you can control:
- Making a larger down payment. Starting with a higher down payment improves the LTV ratio which can qualify you for lower interest rates. Further, if your down payment is 20% or higher, it can eliminate the need for MI altogether.
- Improving your credit score. Credit scores create a standardized way for lenders to judge how reliable you will be in repaying your loan. Monitoring your credit score and checking your credit report for fraudulent activity, while maintaining a punctual bill-paying routine will help improve your score and could help you qualify for a new loan with lower monthly payments.
- Choosing a home loan without MI. An understanding of the loan types that require MI gives you the flexibility to apply for a loan that doesn’t require a form of mortgage insurance.
- Choosing an ARM. Adjustable Rate Mortgages (ARM) can lock in a competitively low rate, typically for a year or more, then adjust or float relative to a benchmarked index rate for the balance of the loan. If the initial rate is sufficiently low, and the index rate is stable, this can be an appealing option. As with all major financial commitments, it’s important to understand what you’re getting into.
Over time, as your needs and finances change, one or more of these strategies can bring your monthly payment down, and even reduce the lifetime cost of your loan. By breaking down your mortgage bill, you can understand which of these strategies applies best to your circumstances.
As you evaluate your options, one of the most important choices you make will be selecting the right lender. PennyMac is focused on finding the right loan for each unique borrower. Unlike a bank, PennyMac is a direct mortgage lender, who can offer multiple options to help you refinance at a rate you can sustain in the long run. To see how we can help, connect with a a PennyMac Loan Officer today or apply online.
*By refinancing the consumer’s existing loan, the consumer’s total finance charges may be higher over the life of the loan.