Housing expenses are one of the biggest expenses people have yet many people do very little to minimize this expense. Shopping to reduce the price of a house that meets your needs is an obvious first choice and many people will do at least a little comparison, but it is much less common to do price comparisons on mortgages which can be a difference of thousands of dollars.
When my wife and I bought our first house together, we both had foreclosures on our credit report (housing bubble issues) so we needed to go the FHA route. Unfortunately, that also meant that we were paying almost $200/month in mortgage insurance premium (MIP) and that amount wouldn’t go away once we hit an 80% loan to value ratio as it would under a conventional mortgage. Recently, the 7-year waiting period expired and we were finally able to refinance our house. Yay! This one step will end up saving us 10s of thousands of dollars over the course of the loan. In this post, I will examine our thought process and how we were able to save so much money.
The biggest factor in the savings is getting rid of the MIP so if you are like the 5 million Americans that lost their home in the housing bubble, you are probably eligible to get rid of this drag on your savings. Let’s look at how much that could save you over the course of the loan. A quick google search shows that the average mortgage amount is around $220,000 which is close to what ours was so I will use our numbers. Back of the envelope calculation given we were paying $165 a month in MIP for a 30-year mortgage is $59,400. This is actually a bit more than we would have saved because when we were ready to refinance, we had paid down our mortgage to about 25 years left and the MIP decreases with the principal of the loan. The MIP is about 1% of the principal, so I plugged our principal balance, interest rate, and years remaining into an amortization calculator then multiplied the balance each month by .01/12 to get the MIP for each month. Then I got the sum of the MIPs for the life of the loan to arrive at a savings of $35,725. This is a massive saving!
The next way we saved money is by reducing our interest rate. Not only did we switch to a lower cost lender, but we also switched from a 30-year mortgage to a 15-year mortgage. This is helpful because the interest rates are lower and it aligns our house payoff date closer to our retire dates. The difference in interest rates between a 30-year and 15-year mortgage is about 0.4% and the difference between lenders ranges about 1% for a total interest difference of 1.4%. For our refinance, this would’ve resulted in total principal and interest payments of $306,349 at the highest to $272,218 at the lowest—a difference of $29,131.
We ended up saving $35,725 in MIP payments and $29,131 in interest payments for a total savings of $64,856. If we convert this into an hourly rate using a conservative 32 hours of work to complete the refinance it would be over $2,000/hour—much higher than my teacher salary. Yes, it took us several hours of gathering paperwork and interacting with our lender, but for the amount of savings, it was well worth it.
Switching to a 15-year mortgage had additional benefits because it more closely aligns our mortgage payoff date with our likely retirement dates. Due to the sequence of return risks, it is ideal to have your house paid off exactly when you retire. You don’t want to pay it off too early because the mortgage provides cheap and safe leverage to increase investments in the stock market while you are working and you don’t want to pay it off after retirement because the increased demands on your cash from mortgage payments exacerbate the negative impact of withdrawing money during down markets.
The higher payments for a shorter term mortgage don’t increase your real housing expense because your mortgage payment isn’t equal to your housing expense. Only the taxes, interest expense, and other fees should be classified as housing expense. The portion that goes toward principal should be classified as savings or debt paydown, not a housing expense. When comparing mortgages with rent or other mortgages, subtract out the principal payments from the total payment to get your real housing expense. Look for the mortgage that has the lowest payment over the course of your expected time there to find the best deal. Remember to factor in rent increases in your projected payments.
Are you currently paying MIP? When do you plan to pay off your house?