A Guide to Lowering Your Monthly Mortgage Payments
Your mortgage has been approved, you’ve made your down payment and paid all closing costs, and you’re ready to move into your new home. But your biggest cost is still ahead of you: your monthly mortgage payments. So, what exactly are these payments, and what can you do to make sure they cost you as little as possible?
What is a Mortgage Payment?
Mortgage payments are monthly payments you will pay to your lender in order to gradually pay off the total sum of your home loan. The size of the monthly payments is determined by the size of the principal at the beginning (the loan minus the down payment) and the term within which the loan must be repaid. The longer the term, the smaller the monthly payments; the shorter the term, the larger the monthly payments. For example, if you take out a $200,000 loan and spread the payments over 30 years, the amount you pay each month will be less than what you pay for a 15-year loan.
What Factors Impact the Payments?
The reason mortgage payments aren’t precisely half the amount for a 30-year fixed rate than they are for a 15-year fixed rate is because of other factors such as interest. Your mortgage payments comprise several components. The largest component is the principal, which is the value of the loan after deducting your down payment. As the months and years go by you will pay off more of your principal and your balance will decrease. When you finally pay off all of your principal, this will mean you’re the proud 100% owner of your home.
You may have heard the acronym PITI, which stands for monthly principal, interest, taxes, and insurance.
These 3 components are:
- Interest: this is the annual percentage you pay the lender for underwriting your mortgage. The higher your interest rate, the higher your mortgage payments.
- Taxes: Government real-estate taxes are calculated on an annual basis, but it can be included in monthly payments.
- Insurance: Depending on your circumstances, your lender may require you to pay property insurance and/or private mortgage insurance (PMI). Property insurance protects the home and its contents from disasters such as fire and theft. PMI is mandatory for borrowers who make a down payment of less than 20%, and it protects the lender in the event that the borrower defaults on their payments.
What Does an Average Payment Look Like?
A useful way of understanding how your payments change over time is with an amortization calculator (which many websites can create for you for free). Because your principal balance decreases over time, your mortgage will consist primarily of interest payments in the first few years and primarily of principal in the last few years.
Below is an example of a 30-year fixed rate mortgage with a total value of $200,000 and a 5% interest rate. The amortization schedule comprises 360 monthly payments. This example shows how the balance between principal and interest reverses over the course of the 30 years. It doesn’t take into account taxes or insurance, nor does it consider the possibility that the borrower might pay off all or a portion of the principal balance ahead of schedule.
When Do You Start to Pay?
Monthly payments are due on the first of each month, and the first of these payments is due the month after the calendar month following closing. Therefore, if your mortgage closes January 15, your first monthly payment will be due on March 1. If your mortgage closes January 5 or January 25, the date of your first monthly payment will still be March 1. Unlike rental payments, mortgage payments are made in arrears, meaning that on March 1 you pay principal and interest (and applicable taxes and insurance) for February, and on April 1 you pay for March.
Which is Preferable: a Shorter Term or a Longer Term?
The longer the term, the smaller the monthly payments; the lower the term, the higher the monthly payments. As a general rule, it is better to pay off a mortgage, or any other type of loan or debt, as quickly as you can. Although the monthly payments on a 15-year fixed-rate mortgage are higher than on a 30-year mortgage, the total payments in sum on a 30-year mortgage are higher than on a 15-year mortgage. To answer whether a shorter or longer term is best for you, you need to ask yourself if you are able to pay off the higher monthly payments offered with the shorter term.
While the annual interest rate on a 15-year fixed-rate mortgage will always be higher than a 30-year rate, your total interest payments over the life of your 30-year mortgage will be higher. Again, using the example of $200,000 principal with 5% interest rate, and excluding taxes and insurance, you would pay $1,073.64/month for a 30-year mortgage, and $1,581.59/month for a 15-year mortgage. If you are certain you can comfortably meet the higher monthly payments of the 15-year mortgage (and still have enough money left over for other planned and unforeseen costs), then this is undoubtedly the better of the 2 options.
Tips for Lowering Your Monthly Payments
Whether you’re just about to close on your mortgage or have already begun paying off the balance, there are many different ways in which you can lower the size of your mortgage payments.
Before closing, you can:
- Make a larger down payment. If you’re able to pay down 20% on a $200,000 loan instead of 10%, that’s an additional $20,000 in reduced principal on which you won’t have to pay interest. Also, if you pay 20% or more, you won’t need to pay private mortgage insurance each month.
- Pay PMI upfront. If you aren’t able to make a 20% down payment, you at least have the option of paying PMI in a one-time upfront fee rather than including it in your monthly payments. As always, the same golden rule applies: if you are able, it’s always better to pay off more now and reduce the amount to be repaid later.
- Agree to a longer term. If your goal is to reduce your total payments, you should always opt for as short a term as possible. But if your goal is to reduce your monthly payments (and you understand this will cost you more in the long run), then you should agree to the longest term possible: 30 years.
After closing, you can:
- Refinance your mortgage. This involves getting a new lender to pay off your old mortgage, and in exchange they offer you a new mortgage at a lower rate. If interest rates are lower now than when you closed your mortgage, or if your credit has improved significantly since you closed your mortgage, then a refi might be a good option for you. Keep in mind there are closing costs involved, so a refi is only a good idea if you have at least a few years left to pay off your principal.
- Extend your repayment term. Some lenders will allow you to extend your term to up to 40 years for a fee of just a few hundred dollars. As a result of extending your term, your monthly payments will decrease but your total interest payments will increase.
- Make prepayments. Depending on the conditions set out by your lender, you may be able to pay off all of your principal or a portion of your principal earlier than scheduled. Some lenders charge a penalty for prepayments; you can ask them about this when applying for your mortgage.
Monthly payments are composed of a number of factors and are never set in stone. Every borrower has different financial needs and different financial considerations. If you have specific questions or concerns about your monthly payments, you should always raise these with your lender when opening your mortgage application.
Find a qualified lender with the mortgage payments that work for you; ask about the combination of principal, interest, taxes and insurance for the property you are interested in.