We all know mortgage interest rates are increasing. While they’ve seen periods of relief here and there, the trajectory seems to be decidedly higher.
How much higher remains to be seen, but there’s a good chance the rate you receive on a mortgage today won’t be as low as it was a year ago, or even a month ago.
Let’s be clear though; there’s no reason to get upset here – mortgage rates are still on sale, while home prices might not be.
Sure, your 30-year fixed is no longer being offered at an absurd 3.5%, but a rate of 4.5% or even slightly higher is still pretty fantastic, especially if all other rates (like savings accounts) keep rising and you’re locked in for the next three decades.
But if you just can’t accept it, there is something you can do to reverse the damage of that higher rate.
Just Pay More
- There’s no magic formula here
- If you have a higher interest rate than you’d like
- You can simply pay your home loan down faster
- To lessen the blow
It’s really quite simple. If you want your mortgage to cost you less, pay more each month.
While the interest rate might be set in stone (barring a refinance), you’re generally allowed to make any payment you’d like each month, so long as it’s enough to satisfy the minimum payment.
So if your monthly mortgage payment is $2,000, you’re welcome to pay $2,500 or even $3,000 if you want, if you have the capacity to do so.
As long as your loan servicer allows you to make larger payments and direct the overage to the principal balance, you’ll offset the cost of a higher mortgage rate.
Let’s look at a simple example to illustrate:
$350,000 loan amount @4.5% 30-year fixed
Monthly payment: $1,773.40
Total interest paid over the life of loan: $288,424
Did You Miss the Mortgage Rate Sale?
- Even if you didn’t get the lowest rate possible
- You can still save on interest and pay less
- If you have extra money set aside to make larger payments
- Just be sure it’s the best place for your money
Assuming you missed the mortgage rate sale that took place over the past few years, you might be stuck (and I use that word very loosely) with a rate that is around 1% above all-time lows.
Again, this isn’t necessarily a bad thing. It’s like missing out on a crazy fire sale but still cashing on a really, really good sale.
Anyway, our hypothetical homeowner is now on the hook for about $288,000 in interest over the course of 30 years because they had to settle for a rate of 4.5%.
Had they locked in a rate of say 3.5% a couple years earlier, the total interest amount would be closer to $216,000. That’s a difference of about $72,000 assuming the loan is held to maturity, which it probably won’t be, but let’s continue.
If our homeowner had the ability to make larger monthly payments, they could close the gap and limit the damage of that higher interest rate.
In fact, just paying an extra $200 per month, or $1,973.40, they’d whittle the total amount of interest down to about $208,000 over the full term.
They’d also pay off the mortgage nearly six years early, so their 30-year fixed would become something like a 24-year fixed.
My early payoff calculator can help you to determine your own loan scenarios quickly and easily.
Now this obviously requires a home buyer to have more money at their disposal to make extra mortgage payments, but it illustrates the ease at which one can reverse a rate increase through some simple financial maneuvering.
This also demonstrates the importance of buying a home within your budget, to ensure you have money to spare.
As I alluded to earlier, most homeowners don’t keep their mortgages for the full term, or even close to it, so another easy option would be to opt for an adjustable-rate mortgage, such as a 5/1 ARM or 7/1 ARM, both of which might price closer today to what we used to see on the 30-year fixed.
Of course, an ARM comes with much more risk and uncertainty, whereas making larger-than-required mortgage payments is purely a choice that you can stop at any time.
There’s also a 15-year fixed mortgage, which comes at a discount to the 30-year fixed, though it’s harder to qualify for because payments are much higher.
But again, there are plenty of options here. The same isn’t true about buying a home at a given price. Once you buy it, the price you paid is the price you paid.
So it might be better to pay closer attention to home prices than mortgage rates.
The Same Principle Applies When Rates Are Low
- When mortgage rates are super low
- It could make sense to slow mortgage repayment
- Because the cost of financing is very attractive
- And there might be a better place for your money where it earns a higher rate of return
When mortgage interest rates were really low a few years ago, a lot of borrowers were refinancing their home loans into shorter-term products like the 15-year fixed.
While that sounds like a great move on the surface, they were doing it at a time when mortgage financing was never cheaper. And might not ever be again.
Put another way, mortgages were on sale like they had never been before and homeowners were trying to get rid of them faster than ever.
It may have actually made better sense to get a 30-year fixed instead of a 15-year fixed and just sit on it for three decades. That way they could benefit from the sale for a longer period of time.
But I understand that some individuals want to extinguish any debt as soon as possible, which is their prerogative and certainly not a terrible thing.
It seems those who pay off the mortgage before retirement are able to retire faster (or simply retire to begin with). So there’s nothing inherently wrong with going with a shorter-term mortgage.
However, one should pay attention to their mortgage rate relative to what else is out there, and manage it accordingly. And understand that they always have choices.
Ultimately, a mortgage should be viewed like any other financial instrument. It needs ongoing attention to ensure it’s being handled correctly based on the economic climate.