The Not-So-Secret Way to Build Equity?
Phawat Topaisan / EyeEm / Getty Images APRIL 4, 2023 The Not-So-Secret Way to Build Equity? By Charity Ohlund Rather than paying a mortgage monthly, make a half payment every two weeks, equaling one extra payment per year. It can shave about 6 years off a 30-year loan. every year? No, not the one where you make a full extra payment at the end of the year. That’s not a secret and coming up with an additional full mortgage payment, especially in December, is not that cool. By default, mortgage payments are made once per month, equating to 12 full mortgage payments in a year. But what would happen if you were to make biweekly payments? Under this strategy, either you or your lender would split your monthly payment in half and submit a payment every two weeks. This is where a quirk in our calendar allows you to get ahead. There aren’t a uniform number of days in each month, and so by making biweekly mortgage payments, you’ll make 26 “half-payments,” or 13 “full” payments per year instead of the normal 12 payments. In other words, you make one extra full payment per year, and you won’t even feel it because you’ve budgeted for it. It’s important to distinguish here that we are talking about equal payments every two weeks – not two equal payments per month. That would equal 24 half payments, or 12 full payments. That’s fine if you just want to avoid a large withdrawal around the first of the month. But it’s the 26 half payments that really begin to offer some additional benefits. Such as … Pay less interest over timeWhen you make a mortgage payment, the bank actually splits up the money and divvies it out into various things. During the first few years after you take out your mortgage, most of the money will be going toward interest and very little will be going to reducing the balance of your loan (sadly). This process is called amortization, and anyone who’s ever had a loan literally had to pay their dues, especially during those first few years.But here’s where making biweekly mortgage payments can really help you. Since you’ll be making an extra payment each year, you’ll pay down the principal even faster. This means that each interest payment thereafter will be smaller than if you hadn’t made that extra payment. Over the course of your loan, this can save you a significant amount of money. Build equity fasterContinuing that thought, one of the biggest benefits of making biweekly mortgage payments is that you build home equity faster. When you make biweekly payments and manage to squeeze in that extra payment each year, you’ll be making extra payments toward reducing the balance of your loan. And that extra payment will give you a small push toward building equity.There are a lot of advantages to having as much home equity as possible. For example, if you have enough home equity, you can take out a home equity loan to finance things like home repairs or remodels, or you can increase your proceeds when and if you sell your home. Drop your PMI soonerIn 2021, the average homebuyer bought their home with a 10% down payment. That’s not bad, but for most conventional loans (not including FHA, VA and USDA loans), you’ll need a down payment of at least 20% to avoid paying for private mortgage insurance (PMI) each month. Once you reach 20% equity in your home, you can ask your conventional lender to cancel your PMI payments. If you make biweekly payments, you can actually get there a lot faster because you’ll be paying down the balance of your loan quicker than normal. Paying off your mortgage soonerBy now, you get the idea so I won’t belabor the point. But when you make an extra payment, you’ll pay off your loan quicker. Let’s look at a quick example. This scenario assumes a $300,000 loan with a 30-year fixed term at 5.750% APR: Payment Amount: $1,751 Number of payments per year: 12 Total paid per year: $21,012 Number of years to pay off: 30 Total interest paid: $330,258 Total Cost: $630,360 Biweekly payment Payment amount: $875.50 Number of payments per year: 26 Total paid per year: $22,763 Number of years to pay off: 24 years 10 months Total interest paid: $263,000 Total cost: $563,822 © Copyright 2023 Shawnee Mission Post, All rights reserved.
Good news for homebuyers. Mortgage rates just dropped again
- Source: CNN Business " data-fave-thumbnails="{"big": { "uri": "https://media.cnn.com/api/v1/images/stellar/prod/220520163214-us-homes-for-sale-0314.jpg?c=16x9&q=h_540,w_960,c_fill" }, "small": { "uri": "https://media.cnn.com/api/v1/images/stellar/prod/220520163214-us-homes-for-sale-0314.jpg?c=16x9&q=h_540,w_960,c_fill" } }" data-vr-video="" data-show-html="" data-check-event-based-preview="" data-network-id="" data-details=""> Washington, DCCNN — Mortgage rates dropped again this week for the second week in a row amid lingering concerns about bank failures and uncertainty in the financial markets. The 30-year fixed-rate mortgage averaged 6.42% in the week ending March 23, down from 6.60% the week before, according to data from Freddie Mac released Thursday. A year ago, the 30-year fixed-rate was 4.42%. “Mortgage rates continued to slide down as financial market concerns came to the fore over the last two weeks,” said Sam Khater, Freddie Mac’s chief economist. That’s good news for homebuyers who are seeing rates retreat slightly and home prices stabilize. “If mortgage rates continue to slide over the next few weeks, look for a continued rebound during the first weeks of the spring homebuying season,” he said. The average mortgage rate is based on mortgage applications that Freddie Mac receives from thousands of lenders across the country. The survey includes only borrowers who put 20% down and have excellent credit. Fed signals rate hikes coming to an end After hitting a 2022 high of 7.08% in November, rates had been trending down. However, they started climbing again in February. Robust economic data suggested the Federal Reserve was not done in its battle to cool the US economy and would likely continue hiking its benchmark lending rate. It did so on Wednesday. The Federal Reserve raised interest rates by a quarter point in an effort to continue to fight stubbornly high inflation while taking into account recent risks to financial stability. Yields on 10-year US Treasury bonds climbed on Tuesday ahead of the meeting as investors prepared for the impact of the committee’s revised rate projections, said Hannah Jones, economic data analyst at Realtor.com. But rates fell on Wednesday on news from the Fed that its series of aggressive rate hikes could be coming to an end. Five big takeaways from the Fed's extraordinary meeting: The Fed emphasized a commitment to cooling inflation to its 2% target, but pulled back its stance on additional rate increases. Fed Chair Jerome Powell said recent banking sector instability is likely to lead to tighter lending requirements, which could serve to cool inflation. “Depending on the extent of the impact of a tighter banking sector, Powell expressed a ‘wait-and-see’ approach to further contractionary policy,” Jones said. “However, the federal funds rate is expected to remain elevated through the end of the year, meaning that a higher interest rate environment is here to stay for the time being, including for home loans.” The Fed does not set the interest rates that borrowers pay on mortgages directly, but its actions influence them. Mortgage rates tend to track the yield on 10-year US Treasury bonds, which move based on a combination of anticipation about the Fed’s actions, what the Fed actually does and investors’ reactions. When Treasury yields go up, so do mortgage rates; when they go down, mortgage rates tend to follow. Home affordability is not improving While a slight retreat in rates over the past week boosted applications, home affordability worsened through February. “Mortgage applications increased for the third consecutive week, despite the ongoing volatility in the financial markets and the broader economy,” said Bob Broeksmit, president and CEO of the Mortgage Bankers Association. While rates remain much higher than a year ago, he said MBA is forecasting a gradual decline, with the 30-year fixed rate falling to around 5.3% by the end of the year. Homebuyer affordability declined in February, according to MBA, with the national median monthly payment for those applying to purchase a home rising nearly 5% to $2,061 from $1,964 in January. New home sales rose for the third month in a row: Ongoing affordability challenges weigh on buyers and sellers preparing for the spring housing market, said Jones. “Each downward tick in mortgage rates is met with increased buyer demand, as many eager home shoppers take advantage of the slightly lower cost of financing a home,” she said. “Home shoppers are looking to find the optimal combination of prices and mortgage rates before entering the market.” But, she added, elevated rates and high prices mean that point doesn’t yet exist in the market for many would-be buyers. “At the current price and mortgage rate level, the typical housing payment on a median-priced home is 43% higher than one year ago,” said Jones.
How does a mortgage rate buy-down work?
A temporary buy-down provided by the seller allows the borrower to have more money available during the early years to handle furnishing and renovation costs. (Jim Lo Scalzo/EPA-EFE/Shutterstock) Higher mortgage rates — up nearly double over a year ago — cut into affordability and increase monthly payments for buyers. Rising rates are particularly challenging for buyers who may be struggling to afford their first home or those who hope to move up into a larger and more expensive property. While there are multiple strategies to manage higher mortgage rates, one option to consider if you have some extra cash is to buy down the interest rate temporarily. We asked for advice about this strategy from Peter Idziak, an attorney based in Dallas at residential mortgage law firm Polunsky Beitel Green; David Cox, a sales manager and senior loan originator in Boulder, Colo., with Cherry Creek Mortgage; and Karla Melgar, a senior loan officer in La Plata, Md., with Embrace Home Loans, which is based in Middletown, R.I. All three answered by email and their responses were edited. What is a buy-down and how does it work? Idziak: A temporary buy-down is a cash payment that effectively lowers the borrower’s interest rate for a limited period, allowing borrowers to reduce their monthly payments during the early years of the mortgage. The party providing the buy-down funds will normally make a lump-sum payment into an escrow account at closing. The borrower pays a monthly payment based on the reduced or “bought down” rate and the funds from the escrow account are used to make up the difference to the lender. Although a party can agree to buy down the rate by any amount and for any length of time, the most common buy-down agreement calls for the interest rate to be reduced by a certain number of whole percentage points (i.e., reduced from 5 percent to 3 percent) and then increase 1 percent per year until it reaches the undiscounted note rate. Melgar: A buy-down is a mortgage financing technique in which the buyer obtains a lower interest rate for the first few years of the mortgage. It is a way for a borrower to obtain a lower interest rate by paying extra cash at closing so their monthly payment is based on an interest rate that is typically 1 percent to 2 percent below the note rate. The first-year rate on a buy-down is often referred to as the “start rate.” For example, the interest rate on a 2-1 buy-down would be 2 percent below the note rate for the first year and 1 percent below the note rate for the second. Then years three through 30 would be at the note rate. How much does a buy-down usually cost? Idziak: The cost to temporarily buy down the interest rate will depend on the size of the mortgage loan and the amount and duration of the buy-down. The calculation used to buy down the rate may also differ among lenders but is usually about equal to what the borrower saves in interest. As an example, using the average mortgage ($415,000) with a 30-year term, a 2-1 buy-down would cost approximately $9,000 and a 3-2-1 buy-down would cost around $17,000. Cox: For a buyer who makes a down payment of 20 percent, the cost to fund the escrow or buy-down account for a 2-1 buy down is about 2 percent of the purchase price or about 1.7 percent of their loan amount. The dollar amount required to fund the buy-down account is a calculated amount needed to supplement the buyer’s discounted payment over the two-year period. Who usually pays for a buy-down? Cox: The escrow or buy-down account can be funded by the seller, the buyer, the lender or a third party, such as a Realtor. Getting the seller to accept a concession to fund the account is usually the most beneficial scenario for the buyer. Melgar: A buy-down can be paid by the buyer, seller, mortgage lender or builder. In my experience, buy-downs are most often used in new home construction and the builder typically pays for it. What is the benefit of a buy-down? Idziak: Home affordability concerns are at the forefront of many buyers’ minds in the current environment. The first few years of homeownership are often the most expensive, especially for first-time buyers. Furnishing a home and completing renovations or upgrades are often major expenses for buyers. A temporary buydown provided by the seller allows the borrower to have more money available during these years to handle such costs. Borrowers often expect their incomes to increase in the future. Lower monthly payments during the first few years of a mortgage can allow a buyer time to adjust to what, for most, will be a higher monthly housing expense. For buyers who qualify for a mortgage but may be worried about their short-term financial picture, a temporary buy-down may give them the confidence to take out a mortgage and purchase the home. How does a buy-down impact a loan qualification? Is the buyer qualified on the lower rate or the later rate? Idziak: Fannie Mae, Freddie Mac and the Federal Housing Administration require the borrower to qualify at the note rate. If the borrower needs a lower interest rate to qualify for the loan, Veterans Affairs will allow the borrower to qualify based on the first year’s payment if there are “strong indications” the borrower’s income will increase to cover the yearly increases in loan payments. Such strong indications include confirmed future promotions or wage percentage increases guaranteed by labor contracts. It’s important to note that under the federal Ability to Repay Rule, most lenders are required to make a reasonable and good faith determination that the borrower has the ability to repay the loan using the borrower’s monthly payment without considering the temporary buy-down. This requirement helps prevent past abuses of using introductory or “teaser” rates to qualify a borrower who would not have qualified for the mortgage using the permanent interest rate. What are the advantages of doing a buy-down rather than making a bigger down payment? Idziak: For borrowers who may not plan to be in the home more than a few years — or who expect rates to go down and to refinance in the near future — using a seller concession to purchase a temporary buy-down can result in greater savings to the borrower compared to using funds to make a larger down payment or to buy points to permanently bring down the interest rate. As noted above, for borrowers who expect to have a higher income in the future, using their funds or seller concessions to concentrate the benefits in the first few years of the mortgage when money may be tightest can be a savvy financial planning tool. Cox: Compared to a larger down payment or even paying discount points [which are equal to 1 percent of the loan amount] to permanently buy down the interest rate, the 2-1 buy-down yields a much shorter break-even point. For example, at current interest rates, a larger down payment will only impact the monthly payment by about $5.40 for every $1,000 or about $54 a month for an extra $10,000 down payment. For a 2-1 buy-down scenario in which the purchase price is $600,000 with 20 percent down and $10,000 is put toward the buy-down, the buyer’s payment would be reduced by $550 a month during the first year and $285 a month the second year. Melgar: The buy-down will sometimes allow the purchaser to consider a larger home, especially for first-time home buyers who anticipate a growing family. This type of loan is also popular with buyers who know their income will increase over the next two to three years. What are the disadvantages of doing a buy-down rather than making a bigger down payment or paying discount points for the loan? Idziak: Buyers who plan to own the home for a significant length of time may benefit more from a lower monthly payment over the life of the loan, as opposed to a temporary reduction in payments over the first few years of the loan. For such buyers, using those funds to buy points to permanently reduce the interest rate or toward a larger down payment may result in greater savings over the life of the loan. Additionally, borrowers putting less than 20 percent down on a conventional purchase are normally required to purchase mortgage insurance. The cost of such insurance over the life of the loan could outweigh any benefit a borrower would receive from using their funds to fund a temporary buy-down. Cox: A disadvantage of the buy-down is the homeowner’s payment will increase after the first and second year before stabilizing in the third year going forward, so eventually they will have to adjust their monthly budget for those larger payments. Any other comments? Idziak: Most conventional or government loans have limits on so-called “interested party” contributions, which are costs normally paid by the purchaser but covered by another party to the transaction. Buy-down funds provided to a borrower by another party to the transaction are included within these limits, so buyers should be aware that their lender may limit the amount of money a seller, developer, real estate agent or lender can contribute to fund a buy-down. Cox: The 2-1 buy-down program is a phenomenal way for buyers to ease into their new mortgage payment. This program also is a great way for buyers to get into a home sooner and benefit from price appreciation immediately, rather than waiting to buy in hope that rates drop in the future. If the buyer were to sell, refinance or pay off the mortgage before the end of the second year, the remaining escrow or buy-down funds are refunded to them or applied toward the payoff of their mortgage.
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