Now that you’ve dug into your budget and know how much you can afford to spend on your new home, it’s time to start shopping … not for your new house, though, for your mortgage. It’s not quite as much fun as walking through houses and picturing yourself moving in, but it is a key step toward your new front door. You might be surprised at how much of an impact seemingly small differences in mortgage details make in the long term.

How Much Money Should I Put Down?

First off, consider your down payment. Certain mortgage options will have requirements for the percentage of money you need to put down in the deal, but if there isn’t a set requirement, you’ll need to decide what number makes sense for you.

Making a bigger down payment will reduce the amount you borrow in your loan and reduce your monthly payments as well. Depending on the details of your mortgage, putting down a certain percentage will also help you avoid needing mortgage insurance (also known as MI or PMI). PMI is an extra fee you pay every month until your loan-to-value ratio (LTV) drops below a set percentage, and the PMI fee drops off. Unlike most insurance products, mortgage insurance isn’t there to protect you—its sole purpose is to protect your lender in the event you default on your mortgage.

A larger down payment may also qualify you for a lower interest rate from your lender because it reduces the risk of your mortgage loan. We’ll talk in the next section about the impact your interest rate makes.

Putting more money down will reduce your long-term costs, but that doesn’t mean you should drain your savings to maximize your down payment. Maintaining your emergency fund is a critical piece of a wise financial strategy. Any money you’d save with the larger down payment flies out the window if you lose your job, have a major medical issue with bills to match, or any other of countless expensive scenarios play out in your household. Ideally, you’ll put the largest amount down that you can afford without throwing the rest of your budget (including savings) out of balance.

Let’s look at how different down payment amounts affect the same mortgage.

Purchase price = $150,000
Down payment = $30,000 (20%)
Interest rate = 4.25%
Loan term = 30 years
Monthly payment = $873.66
Total = $314,518.03

VS.

Purchase price = $150,000
Down payment = $7,500 (5%)
Interest rate = 4.25%
Loan term = 30 years
Monthly payment = $1,103.10 ($118.75 PMI)
Total = $365,765.16

In this example, you’ll spend $11,400 on PMI before your LTV is high enough to remove the expense. On top of that, the higher starting principal balance (how much you borrowed) racks up quite a bit more interest over the 30-year life of the loan. In all, a down payment of $7,500 vs. $30,000 will cost you almost $29,000 in PMI and additional interest over the life of the loan. To keep it simple, the rate is the same in both examples, but if your higher down payment earned you a lower interest rate, the difference would be even greater. Speaking of interest rates …

What’s the Deal with Interest Rates?

How does your mortgage lender decide what your interest rate will be? It depends on a few factors—your credit score, the length of your loan, economic factors, and your lender’s range of rates. Obviously, there isn’t really anything you can do about the economic outlook and what the Federal Reserve decides to set rates at, but you do have a say in the other factors.

Credit score less than great? Look at the factors pulling you down and start working to improve them. Whether that’s bad debts that need to be paid off or a credit utilization that’s too high, take the actions needed to put it right as soon as possible. It can take a while for your credit report to react and your score to improve.

Mortgage lenders don’t all have the same rates. Credit unions in particular (ahem, like GOLD) are known for having lower interest rates on loans because they exist to serve Members, not to profit off customers. The length of your loan is another factor you can control to lower your interest rate, but we’ll talk about that in the next section.

First, we’ll focus on the impact a small difference in interest rate can make on your mortgage.

Purchase price = $150,000
Down payment = $30,000 (20%)
Interest rate = 4.25%
Loan term = 30 years
Monthly payment = $873.66
Total = $314,518.03

VS.

Purchase price = $150,000
Down payment = $30,000 (20%)
Interest rate = 3.875%
Loan term = 30 years
Monthly payment = $847.62
Total = $305,142.42

The difference between interest rates in the two examples (4.25% vs. 3.875%) may seem inconsequential, but it adds up! You’ll save just over $25 every month, and over the 30-year life of the loan, a little under $10,000. Not so inconsequential after all, right? Now on to that third factor you can impact—term.

Is There Just One Type of Mortgage Term?

Although a 30-year mortgage is the most common option, mortgage terms are not one-size-fits-all. You’ve got options! Not only are there shorter terms to choose from, such as the 10- or 20-year mortgage, lenders might also offer you in-between options, like the 15-year mortgage. The main advantage to a shorter term, besides the fact that your home will be paid off sooner, is that you’ll get a lower interest rate and save significant money because the shorter time period allows less interest to accumulate.

Here’s what the numbers look like if you trim the standard 30-year mortgage down to 20 years.

Purchase price = $150,000
Down payment = $30,000 (20%)
Interest rate = 4.25%
Loan term = 30 years
Monthly payment = $873.66
Total = $314,518.03

VS.

Purchase price = $150,000
Down payment = $30,000 (20%)
Interest rate = 4.25%
Loan term = 20 years
Monthly payment = $1,026.41
Total = $246,339.53

The monthly payment does increase (by about $150 in this example), but the total savings is massive—about $68,000.

What’s an Adjustable Rate Mortgage, and is it a Good Idea?

Fixed-rate mortgages where monthly payments are—yes, you guessed it—fixed, are the most typical terms you can pick from. There is another option, though.

An adjustable-rate mortgage (aka, ARM) is a type of mortgage where your rate can change throughout the life of the loan. There are set times where your rate may adjust depending on the two numbers attached to your ARM. For example, with a 5/5 ARM, your rate is locked in for 5 years, then it changes again every 5 years after that. A 7/1 ARM means your rate is locked in for 7 years, then can changes annually afterwards. Because you’re taking on a little more risk as the borrower of an adjustable-rate mortgage, that initial interest rate is usually better than a fixed-rate mortgage.

Whether it's a good or bad idea to get an ARM is totally dependent on your situation and the market conditions. For instance, if you’re confident you’ll be selling your home to move before the first rate change occurs, you can take advantage of the lower initial interest rate and not worry what the rate might be after that. Refinancing your mortgage before or after the initial period may be an option too.

You also have the option of sticking with the adjustable-rate mortgage and seeing how the wind blows with market conditions. When interest rates fall, that works in your favor, but then if rates go up, so do your payments. While there’s always someone willing to guess what the future holds, no one knows for sure. An ARM that changes rates frequently could become a stressor for your budget if conditions don’t play out in your favor.

How Can I Get the Best Mortgage?

We’ve talked through the biggest differences in mortgages and what say you have in each. The math of getting the best possible deal on a mortgage is pretty simple: put down the biggest down payment you can afford, choose a lender that offers the lowest interest rates, choose a shorter term to reduce that rate and how much interest will accumulate even further, and you’re all set! That’s the simple math, but real life and real budgets are a little more complicated. That mortgage designed to cost you the least amount in the long run won’t save you a dime if you can’t afford your monthly payments and default on the loan. That’s why it’s important to know how the components affect your loan, but just as important to understand exactly what you can afford. Picking a 20-year mortgage term instead of a 30-year is awesome if you can afford it, but if your budget says you can’t, stick with the 30-year. Don’t forget, you always have the option to refinance down the line if your situation changes.

Bonus Tip for Saving Money on Your Mortgage

Biweekly payments actually help you pay off your mortgage faster and save you on interest. Even if your lender doesn’t offer the option to pay biweekly, you can calculate what your monthly payment would be divided in half and make the biweekly payments on your own. By the end of each year, you’ll make one full extra payment. That’s because there are 52 weeks in the year equating to 26 biweekly half payments. That’s the same as making 13 full payments, one more than the 12 you’d make paying monthly. Because you’re paying off the principal more quickly, less interest accumulates, and you shorten the amount of time it will take to pay off the loan in full.

One sure-fire tip for getting the best mortgage for you is to work with a lender that has your best interest at heart. At GOLD, that’s what we’re all about. If you’re ready to start talking loans, our Mortgage Consultant is the person you want to talk to. Call 1-800-641-5036 or send an email to mortgages@GOLDcu.org to let us help you find the mortgage that’s best for you.

 

Cori Gosser

About Cori Gosser

Cori is the Vice President of Lending at GOLD. She directs and coordinates all lending activities, oversees a staff of Loan Officers and Associates, and helps GOLD Members take charge of their financial futures with loan products that fit their needs. Cori genuinely enjoys seeing our Members save money and watching their credit scores increase and lives improve due to guidance from her department.

Up Next:

Buying a Home - May 28, 2019

How Much Mortgage Can I Really Afford?

Now that you’ve finally decided to make one of the most important purchases of your life—buying a home—it’s time to crunch those numbers. We’re going to walk you through how to figure it out!

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