A reduced mortgage payment can free up your hard-earned cash for savings, retirement and other beneficial endeavors. It can also help you stay afloat during tough times, even preventing foreclosure. There are many ways to reduce your payment when taking out a home loan or years into your repayment period. Each strategy has pros and cons, so consult mortgage and financial advisers to determine which move is right for you.
Comparing Costs to Savings in a Refinance
A refinance replaces your current mortgage with a new loan. A refinance may allow you to obtain a lower interest rate and better loan terms to reduce your payment. A refinance involves closing costs similar to the fees you pay when taking out a purchase loan. This can add thousands of dollars to your mortgage balance. A refinance may be right for you if:
- Your home has enough equity to meet the lender's loan-to-value requirements.
- You can pay closing costs out-of-pocket or add them to the new loan balance.
- The savings exceed the costs and you keep the loan long enough to realize the savings.
Buying Down the Rate
You can buy a lower interest rate when purchasing or refinancing your home. A rate buydown involves paying an additional sum, or points, at closing. One point equals 1 percent of the loan amount, and the more points you pay, the lower your interest rate. A buydown essentially allows you to prepay mortgage interest at closing. This option may be a good option if:
- You have the funds to pay extra points at closing.
- You keep the loan long enough to offset the upfront cost of a lower rate.
Picking Up an ARM
An adjustable-rate mortgage has an interest rate that's temporarily lower than a traditional fixed-rate loan. Its rate changes at specified times over the life of the loan. Depending on the starting rate and your loan size, it can save you hundreds of dollars each month, at the beginning. Also known as hybrid loans, ARMS have two components that determine when the interest rate adjusts:
- An initial rate period, usually 3, 5, 7 or 10 years in length.
- A subsequent adjustment period, usually a 1-year period.
An ARM is generally considered riskier because the payments increase over time. If you plan to earn more, sell or refinance by the time the ARM rate increases, this might be the right choice for you.
Paying PMI Upfront
Lenders require an additional monthly fee called private mortgage insurance when you refinance with less than 20 percent equity or have less than a 20 percent down payment when purchasing. You pay for PMI coverage monthly along with your home loan to safeguard the lender in case you default. Conventional lenders may allow you to pay PMI upfront at closing to avoid the monthly PMI payment. Or they may allow you to pay it via an increased interest rate. This is known as lender-paid mortgage insurance, or LPMI. Taking a slightly higher interest rate to avoid PMI usually increases your rate by one-quarter to half a percentage point, according to Bankrate.
Removing PMI Through Principal Reduction
If PMI is part of your monthly mortgage payment, you can eventually eliminate it by paying down your mortgage principal. According to the Consumer Financial Protection Bureau, your lender must automatically terminate PMI when your principal balance is scheduled to reach 78 percent of your home's original value. If you have an excellent payment history and a willing lender, you may even be able to cancel PMI earlier. You can request this when your balance is scheduled to reach the 80 percent mark or you've made additional payments to reduce the balance to 80 percent.
Karina C. Hernandez is a real estate agent in San Diego. She has covered housing and personal finance topics for multiple internet channels over the past 10 years. Karina has a B.A. in English from UCLA and has written for eHow, sfGate, the nest, Quicken, TurboTax, RE/Max, Zacks and Opposing Views.