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Good Mortgage Advice For Young, Smart, Home Buyers

The typical young couple, on purchasing a first home, try to buy the most house possible, given their income. As they then go out to buy furniture, other household expenses begin to add up: landscaping, insurance, decorating, and the list goes on. Soon there will be expenses as the family grows and perhaps two income families will be reduced to one income. A pattern may result of living from paycheck to paycheck and of using credit cards for expenses that should be paid out of income.

This state of affairs is likely to last for a long time, the only bright spot being that the mortgage, if fixed, will become a smaller proportion of income as income grows with inflation. The kind of economic difficulties that result may cause stress and marital problems.

Let’s look at a hypothetical young family and track their situation as they fall into the above trap and let’s look at a couple of better choices they could have made that would benefit their pocketbook and their lifestyle.

Randy and Diane are a typical couple in their mid twenties with a family income of $55,000 per annum.

Mortgage lenders will apply the 33/38 debt income ratio. This means that all household expenses (principal, interest, taxes, and mortgage insurance) cannot exceed 33% of gross family income and total debt obligations, including auto, personal loan, and credit card payments cannot exceed 38% of income.

Using this ratio, and assuming that credit ratings and down payment amount are taken into consideration, Randy and Diane could possibly afford a $200,000 mortgage with an fixed interest rate of 7% and a term of 30 years.

Check out this table to see how the "magic of compound interest" works against them:

Mortgage $200,000
Term 30 yrs.
Interest Rate 7%
Monthly Payment $1,330
Total Interest Paid $279,017

Solution #1

If our young couple would settle for less house or a similar house in a different area they could arrange their financial affairs such that they would have more expendable income that could be invested or used for other purposes. The result could very well be less financial stress and a happier family. Let’s assume that they decide instead on a house with a $150,000 mortgage.

Check out this table to see how their situation has eased:

Mortgage $150,000
Term 30 yrs.
Interest Rate 7%
Monthly Payment $1,097
Total Interest Paid $209,263
Interest Savings $233

SOLUTION #2

Our young couple may be willing to carefully budget, keep the $150,000 mortgage and make the same payment as they would have for the $200,000 mortgage. They can do this by choosing a 20 yr term or even a 15 year term. Knowing that they will own a home free and clear in this time period motivates them and gives them a clear light at the end of the tunnel.

If they chose the 20 year term, monthly payments would be $1,162 and they would save $80,000 in interest payments.

The 15 year term would increase their payments to $1,348 per month but there would be a savings in interest of $116,580.

One quick observation would be that Randy and Diane , by choosing a $150,000 mortgage with a 15 year term would pay almost the same amount per month as they would for the $200,000 loan with a 30 year term but they would own their home free and clear in only 15 years and they would have saved $186,000 in interest.

SOLUTION#3

By arranging for a Biweekly payment Randy and Diane would pay a little more but could retire their mortgage obligations even faster and, in the process, save even more interest.

Check this out. If our couple had the $150,000 mortgage at 7% and chose to make Biweekly payments they would pay $674 every 2 weeks. Over the course of the year this would amount to an extra $1,348. However the loan would expire in 12 years and 3 weeks and they would save an additional amount in interest of $14,026.

By doing this Randy and Diane have made "the magic of compound interest" work for them instead of against them. in about 12 years they will own their home and can make some serious investments to enable them to retire early.

Randy and Diane should not pay an upfront fee to a company that promises to make biweekly payments for them. Instead they should calculate a new monthly payment and arrange with their mortgage company to apply the additional amount to principal. To work out the extra amount to be paid each month they simply divide their regular payment by 12. So in the above example our young couple would divide $1,348 by 12 and pay an extra $112 each month.

These are just a few examples of thinking "outside the box" to ensure that you have made the best mortgage decision possible given your own individual circumstances. Use mortgage calculators on the web to work out options that apply to your situation.

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