If you are considering purchasing a home or refinancing—you can go to quickenloans.com or lendingtree.com along with local mortgage lenders in your area—to determine what loan will best suit you—and your family. You can compare closing costs, APR's and Par rates to determine what loan will best serve your—and your family's long-term interests.
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In the following paragraphs we wlll discuss home loan amortization—and how it works. We will also discuss what you need to know if you are considering refinancing your home—so be sure to scroll down to the bottom half of this page—if you are now considering a refinance!
A 30 year home loan may seem deceiving in the way that the principal barely seems to move—particularly in the first few years of the loan. However, it is based on a simple mathematical formula called amortization.
Amortization is the process by which payments of principal and interest are applied toward the amount you borrowed.
Interest is computed on the “current amount owed” and thus gets progressively smaller as the ending balance of the loan reduces.
Let’s say you purchase your home for $200,000 and obtain a mortgage loan for $100,000 at 6.5 percent for 30 years. You would pay principal and interest of $632.07 monthly. For the first month you OWE interest on $100,000 and because you owe interest on $100,000 at this time your interest payment will—and should be—the highest at this point.
As you continue to make payments you will be paying interest on a smaller balance—as your principal (amount you owe) will decrease on a monthly basis.
Principal reduction will be a slow process in the early years of payment because the principal owed is high.
Continuing with the $100,000 mortgage loan example from above you would pay $541.67 in interest with your first payment and $90.40 would go toward the principal. In other words your debt (amount owed) is reduced by $90.40 and you now owe $99,909.60.
Payment number two will now be based on a
balance of $99,909.60, so $541.18 goes to interest and $90.89 goes to principal.
As you make payments month after month the principal applied to the balance will increase and the interest applied to the loan will decrease.
This process continues until your 360th payment contributes $3.41 to interest and $$628.66 to principal.
In this example you would pay off about half your loan in 21 years and 4 months. You would pay off the remaining principal in 8 years 8 months.
Amortization may seem unfair but it is really based on simple math.
If the loan of $100,000 was amortized over 15 years at 6.5%, the monthly principal and interest would cost $871.11.
In the first month you would still pay $541.67 in interest because the amount of the loan and interest rate is the same. However, because the term is cut in half (15 years) you would pay $329.44 in principal with the first payment because you would be paying the loan off faster.
To get an even better grasp of how amortization
works go to bankrate.com and click on calculators from the home page and
mortgages on the pop-up page—which lets you type in any mortgage amount,
interest rate and term, or length of your expected loan—you can also get an
amortization schedule that reflects your expected purchase or refi date,
whether you will make additional payments etcetera.
If you are a homeowner and feel that your mortgage has been miscalculated by your lender and they may owe you money you can go to these sites and calculate and print your amortization schedule:
If you have been making the same payments at the same time of those that are listed on the amortization schedule and there is a discrepancy on your monthly statement in the amount owed you may be owed a refund or you may owe your mortgage company an additional amount.
Mortgage lenders are known to make mistakes and the mistake can sometimes work in your favor or work against you.
If the amortization schedule and your currrent mortgage statement match you are pretty much on target as that means that your monthly payment statement and amortization schedule payments are equal.
Keep in mind if you make additional payments or
your monthly payments are behind that will affect your amortization and you
will have to adjust your amortization calculations accordingly.
Home Credit Counseling:
CredAbility.org (Formerly CCCS)
Be aware that all debt management plans have credit, legal and other risks involved so be sure to obtain competent legal and other independent professional advice.
Some Key Questions To Ask If You Are Purchasing A Home Or Refinancing Your Current Home
If you plan on refinancing your home mortgage or buying your first home be sure to look at the loan “fees” and “transaction costs” and not just rates.
Be sure to shop closing costs as well as rates. Always know how long you plan on living in your home as that is critical in selecting the proper type of loan. Sometimes determining your time frame can be difficult but do your best.
If you plan on staying in your home for 5 or 7 years, you may not need a 30 year fixed rate mortgage. You would then possibly want to consider a five or seven year balloon note in which you pay a fixed rate for 5 or 7 years. The interest rate is usually lower than that of a 30 year loan.
You would also possibly want to consider a 5 or 7 year ARM as their rates are normally lower than that of a 30 year loan and you would not be there when the loan adjusted.
As you can see above, by knowing how long you plan on staying in your home it can save you money.
Some other factors that are based on your time horizon for the loan include:
Many lenders will waive or eliminate certain fees to get or keep your business. Be aware of processing or “junk” fees that lenders are known for tacking on to mortgage loans.
Lenders and Mortgage Brokers are required by law to provide a “good faith estimate” of closing costs to give you (the borrower) an idea of the types of fees you will be expected to pay.
It estimates how much the lender will charge you for origination and discount fees, an appraisal, a credit report, document preparation, title insurance, pest inspection and a host of other costs.
Give extra attention to the line that reads “Estimated Cash At Closing.” That is the lender’s best guess at how much you’ll have to pay out of pocket to get the loan.
How long will it take to break even?
Discount Points Involved:
If you buy a home and pay "discount points" to get a lower rate how long would it take for you to break even? Break Even equals upfront cost of discount points divided by the monthly savings you would get.
For example, let's say you are deciding whether you should pay points on a 30 year $200,000 loan at 6% (monthly payment of principal and interest would be $1193.14).
You are considering buying the rate down 2 points to 5.5%.
2 points on a $200,000 loan would cost you $4,000.
The monthly payment of principal and interest on a 30 year loan of $200,000 at 5.5% would be $1,130.40.
Your monthly savings between the two loans would be $62.74.
$4,000/$62.74 = 63.76 months or approximately 5 years and 3 months.
If your goal was to move within 5 years and 3 months or so—buying down the rate would not make sense because you would not recoup your buy down amount until after that period.
Another way of looking at it is you would have roughly the same "total cash outlay."
If you were to stay past the 5 years and 3 months time period—you would then start to see the financial benefits of the buy down.
This example assumes that one point equals one percent of the loan amount and reduces your interest rate by .25 percent.
This example is designed for fixed-rate mortgages. This example does not take into account the “difference” in the amount of mortgage interest you can deduct from your taxes.
The monthly payment amount does not include taxes, insurance, PMI/MIP or Home Owners Association Dues.
Straight Refinance Involved:
If you are "refinancing" how long will it take to recoup the closing costs from your monthly savings.
Break Even equals closing costs divided by the monthly savings you would get.
For Example, say you have a 30 year $200,000 loan at 6% and your monthly payment of principal and interest is $1193.14. If you refinanced the $200,000 at 30 years at 5% your payment would drop to $1,069.19. A difference of $123.95.
Let's say your closing costs are $5,000.
$5000/123.95 = 40.34 months or approximately 3 years and 3 1/2 months.
If your goal was to move within 3 years or so refinancing would not make sense because you would not recoup your closing costs. Another way of looking at it is you would have roughly the same "total cash outlay."
If you were to stay past the three plus year time period you would then start to see the financial benefits of the refinance.
example does not take into account the “difference” in the amount of mortgage
interest you can deduct from your taxes. The monthly payment amount does not
include taxes, insurance, PMI/MIP or Home Owners Association Dues.
Again, be sure to go over all of the closing documents in detail and give extra attention to the line that reads “Estimated Cash At Closing.”
That is the lender’s best guess at how much you’ll have to pay out of pocket to get the loan.
How long should I lock?
Because lenders and mortgage service providers are swamped and other government regulations are in effect it may be wise to lock in your rate for a certain time period.
Some lenders now have a loan processing backlog of several months. Consider the time needed to process your loan when deciding among lenders to choose from.
Refi's generally make sense if you can shave off 1% or 2 % off your current rate, your time horizon break even analysis is acceptable—and you are in financial position to do so.
Be aware of loans advertised as a “no fee loan” as the fees are often rolled into the principal of the loan at closing, becoming subject to interest over the life of the loan.
You may think that you have a no fee or free loan but the appraisal, title search and origination fees usually show up on the back end and can cost you thousands.
Although many ads may tout a low cost or no fee closing costs—keep in mind that all businesses primary goal is to make a profit and grow their business. In short, there is no free ride.
About This Article:
The above article was written by Thomas (TJ) Underwood. Thomas (TJ) Underwood is an active real estate broker in the state of Georgia and is the writer behind The Wealth Increaser, Home Buyer 411, Home Seller 411, The 3 Step Structured Approach to Managing Your Finances, Managing & Improving Your Credit & Finances for this MILLENNIUM and CREDIT & FINANCE IMPROVEMENT MADE EASY—FREE GUIDE.
He is the creator of TheWealthIncreaser.com where he regularly blogs about helping consumers improve their credit, finance and real estate pursuits in an intelligent, consistent and proactive manner. He’s always looking for ways to make intelligent finance improvement happen for those who “sincerely desire” success in their future.
You can contact him from a number of sources but the most direct way is to contact him through the contact us block that can be found at the bottom of this page.
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