We all know mortgage interest rates have increased tremendously. While there were periods of relief here and there, the trajectory since early 2022 has been 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 perhaps even a month ago.
Simply put, the 30-year fixed is no longer being offered at an absurd 3.5%, thanks to surging inflation and the end of the Fed’s mortgage-backed securities (MBS) buying spree.
Today, you might be facing an interest rate of 7% or even higher, depending on the loan attributes, your FICO score, and so on.
And while it might be hard to accept, there is something you can do to limit the damage of that higher rate.
Just Pay More Toward Your Mortgage Each Month
- There’s no magic formula here or hoops to jump through
- If you have a higher interest rate than you’d like just pay more
- This is a simple way to pay your home loan down faster and lessen the blow
- The more you pay, the lower your effective mortgage rate
It’s pretty straightforward. If you want your high-rate 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, assuming 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 @7.5% 30-year fixed
Monthly payment: $2,447.25
Total interest paid over the life of loan: $531,010
Total interest paid if paying $200 extra per month: $393,796
Did You Miss the Mortgage Rate Sale?
- The 30-year fixed is now averaging 7%+ (up markedly from low levels seen 1-2 years ago)
- Even if you didn’t get the lowest rate possible, you can still save on interest each month
- You can reduce your interest expense if you have extra money set aside to make larger payments
- Just be sure it’s the best place for your money and that you’ve got an emergency fund in place
Assuming you missed the mortgage rate sale that took place over the past few years, you might be stuck with a rate that is nearly triple all-time lows.
Aside from being subject to a higher monthly payment, you’ll also be on the hook for a much larger amount of interest.
Our hypothetical homeowner above is on the hook for $531,010 in interest over the course of 30 years because they had to settle for a rate of 7.5%.
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 $315,000, assuming the loan is held to maturity, which it probably won’t be, but let’s continue regardless.
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 would whittle the total amount of interest down to about $394,000 over the full term.
That’s a savings of $137,000 over the life of the loan, which seems like a pretty big win.
This borrower would also pay off the mortgage nearly seven years early, so their 30-year fixed would become something like a 23-year fixed.
What about an extra $500 per month toward the principal balance? Well, then the total interest is about $291,000 and the loan is paid off nearly 12 years earlier.
My early payoff calculator can help you to determine your own loan scenarios quickly and easily.
Tip: Supercharge your mortgage rate buydown by making the pre-bought down payment!
Cut Spending Elsewhere So You Can Save on Mortgage Interest
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 mortgage 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.
You may also find that there are other recurring costs that can be cut so you’re able to free up additional money to apply toward your home loan.
This will vary by the individual, but if you’re able to make a sacrifice elsewhere, you can potentially save a lot in the process. And take the bite out of a high mortgage rate.
As I alluded to earlier, most homeowners don’t keep their mortgages for the full term, or even close to it.
Another option would be to opt for an adjustable-rate mortgage, such as a 5/1 ARM or 7/1 ARM, though both aren’t offering much of a discount relative to the 30-year fixed.
Of course, an ARM comes with much more risk and uncertainty, whereas making larger-than-required mortgage payments is purely voluntary and 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 monthly payments are much higher.
And you don’t get the option to pay less if you can’t handle the larger payments.
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.
What About When Mortgage Rates Are Low?
- When mortgage rates are super low it could actually make sense to slow mortgage repayment
- Because the cost of financing is very low, paying extra may not be the best option
- Homeowners who locked in 2-3% 30-year fixed rates can probably get a better return in a simple savings account
- Or perhaps their money will earn a higher rate of return in the stock market
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 home loan 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. Yeah, you read that right.
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.
Read more: 6 Ways to Lower Your Mortgage Rate
(photo: Hitchster)