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Mortgage Strategies

By David Luhman on Mon, 05/11/2009 - 23:31

Mortgage Strategies

How mortgages work

Should you prepay your mortgage?

When to refinance your mortgage

What type of mortgage to get

How mortgages work

Mortgages allow you to leverage your investment

Example of how leverage magnifies your returns

Buy a $100,000 home

Put $20,000 down

Home prices increase 10 percent - your home's value increases to $110,000

Your investment was only $20,000 and you saw a $10,000 increase in your equity

Your investment has increased by 50 percent!

Leverage also works the other way!

Most mortgages are amortized

Slowly pay off interest and principal

Most of initial payments are devoted to interest

After 10 years of a 30 year mortgage, you've only paid off about 10 percent of the principal!

Mortgages are one of the biggest expenses in your life

On a $100,000 mortgage at 9 percent you'll pay $189,000 in interest over the life of the mortgage

Almost twice the amount borrowed!

Should you prepay your mortgage?

It's true that you can save thousands of dollars by prepaying your mortgage

It's also true that if you invest in stocks instead of prepaying your mortgage, you'll probably have thousands of dollars in assets

It's probably better to save through a deductible IRA or other retirement account than it is to pay off your mortgage early

Here's why

Mortgage debt has a low after-tax rate

Home equity is counted as an asset for college financial aid considerations -- retirement account assets generally aren't

Using deductible retirement accounts reduces your taxes now and builds assets for your future

Investing in retirement accounts diversifies your holdings

But if you're already putting the maximum deductible amount into your retirement accounts, you may want to pay off your mortgage early

When to refinance your mortgage

Generally refinance when mortgage rates are 2 percent below the rate you're paying now

But this depends on refinancing costs and how long you plan to stay in the home

Remember that points (prepaid interest) paid on a refinance are not immediately tax deductible

These points must be amortized over life of the mortgage

What type of mortgage to get

Understand the trade-off between points (prepaid interest) and the mortgage's interest rate

More points -> lower ongoing interest rate

The amount of points you should be willing to pay depends on how long you plan to live in the house

Adjustable rate mortgages (ARMs) usually mean lower monthly payments -- at least initially

Be wary of ARMs

If rates shoot up you may not be able to make payments

If you're thinking of using an ARM because the lower payments make the home affordable, you're probably buying more house than you can afford

Although fixed rate mortgages are a little more expensive, they provide peace of mind because your payments can't increase

Think about using a modified variable mortgage if you have special circumstances

Fixed payments for a certain period, then floating after that


You plan to stay in a home for only 5 years

You may want to get a 5-25 mortgage

  • Fixed payments for 5 years
  • Floating payments for next 25 years

Make sure to shop around for the best mortgage

Even look outside of your state

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