Buying a home is one of the largest and most long-term investments an individual can make. But many people see it as their home and not an opportunity to create a nest egg. With a little planning and savvy, your home can be a safe haven for your family and your finances.
When you buy a home and obtain a mortgage, the mortgage lender retains a majority ownership in the property. As you pay down the mortgage, the lender's percentage of ownership decreases and yours increases. This increase in ownership is referred to as equity. Your equity in your property is how much of its market value is yours.
Most buyers tend to put down the minimum amount of cash, request the largest loan they can and still attempt to negotiate a low interest rate, but unsuccessfully. Doing the first two tends to weaken your odds of getting a low interest rate. Also, you're walking away from the closing with a very small amount of equity. If possible, when purchasing your home, deposit as much money as you can afford, take the smallest loan you can and negotiate for the lowest possible interest rate. Not only are you likely to get a better interest rate this way, you walk away from the closing owning more of your home than you would have and possibly a lower monthly mortgage obligation than you were expecting.
What should you do with the extra money you'll have every month thanks to your smart closing negotiations? Make payments toward the loan principal. You were willing to pay that much anyway, so do so. Very little of your monthly mortgage payment actually goes toward principal. A monthly mortgage payment is broken up into three separate payments by the lender. The first payment is to the interest, which is calculated by multiplying your current loan balance by your interest rate and then dividing by twelve. After that is deducted from the mortgage payment you tendered, the lender takes real estate taxes, homeowners insurance and any other insurances and places those funds in an escrow account to be paid out yearly. The remaining balance goes to principal. A monthly payment of over $700 on a loan of $78,000 with a 6% interest rate pays $390 directly to interest. After the escrow payments is made, your $700 payment only brought the principal balance down by $132. As you can see, the bulk of your monthly payment goes toward interest and will continue to do so until the balance is reduced dramatically (think 15 years of payments give or take). The more principal you pay and the earlier you start paying it results in paying less interest monthly and over the life of the loan. As your loan balance goes down your equity in your home increases.
Contact your mortgage lender and ask them if they have an equity enhancement program and for the program details assuming they have one. Wells Fargo Home Mortgage, for example, does have an equity enhancement program. Wells Fargo will take half your monthly mortgage payment every payday via electronic withdrawal, equaling 26 partial payments as opposed to 12 full payments (there is a small yearly fee for the service). This translates into making roughly 13 full mortgage payments a year, one of which goes entirely to principal. You can also request they withdraw more than half each payday and apply the extra to principal, which I strongly recommend.
A $700 monthly mortgage obligation becomes a $350 bi-weekly transfer of funds and at least $700 in additional principal is paid yearly. However, requesting the lender take $400 bi-weekly is only an extra $50 per payday. This brings your balance down roughly $2,000 every year in addition to the principal that comes out of your standard monthly obligation. All that balance paid translates into equity for you.
Should your lender not have an equity enhancement program, don't fret. If your bank or credit union has a web-bill pay option then you can set up your own enhancement schedule. Call your lender and direct them to note on your account that all over payments go directly to principal unless you specifically request otherwise. Make your monthly payment on time. Set up an automatic recurring bi-weekly transfer of funds totaling half your monthly obligation, or more, through your banks web-bill pay service.
Note: If you receive bi-weekly paychecks from your employer I suggest waiting until one of the two months of the year when you receive three checks to do this, but you can do it whenever if your finances allow.
If your bank or credit union is your mortgage lender, they may have already suggested establishing automatic monthly payments. Take them up on the offer, ask them to take smaller bi-weekly payments, and increase those payments by as much as you can reasonably afford. It's less complicated, you'll never be late and you will be building equity in your home.
Do not take loans against your equity unless it is absolutely necessary, as in life or death. You hate your car; you want to take the kids on a nice vacation, etc., whatever, is not worth it. You will lose the carefully accumulated equity and end up making what amounts to two mortgage payments a month. Not only will you own even less of your property than you did before but your home will be costing you money in multiple interest payments and that's a bad investment.
One possible exception to the preceding advice is a home improvement loan. Making much needed repairs and renovations, as well as simply beautifying your home, do increase property value. If you can take a loan without shooting yourself in the wallet, okay, but be careful, don't take too much, and MOST IMPORTANTLY: Make the improvements!
Remember too, market trends in your neighborhood should be considered when deciding to improve or not. I know of one couple that ignored the changing climate in their community and made thousands of dollars in renovations to their home. Their property's value still fell to below fair market price due to location. They have a beautiful house in a horrible neighborhood, a high mortgage, a high equity loan, no actual equity and they can't get what they paid for it five years ago.
What about refinancing? Refinancing is an attractive but dangerous option. You've been paying down your loan and building equity presumably for a few years now. By refinancing you've increased your financial obligation to a lender and lost your hard earned equity. For example, you spent five years paying down $14,000 of your original $78,000, 6% fixed interest rate, thirty year mortgage. You have twenty-five years to pay off $64,000; you are in a good position to pay that off early. Let's say your property has doubled in value since you purchased it and you are being offered a refinance of $156,000. $64,000 of that goes to pay off your original mortgage. After closing costs and the like, you can probably expect to walk away from the refinance with an easy $80,000 in your pocket. Close to what you paid for your house in the first place.
While all that is true, you are also now on the hook to pay off a $156,000 mortgage over the next 15 to 30 years depending on the terms of the refinance. You have very little equity in your home. And even if you were lucky enough to hold on to your 6% fixed interest rate, you're likely to be paying a higher monthly payment than before, with no extra being available to pay down the balance. Still think that refinance is such a great deal?
There are times when refinancing is a good idea. The rule of thumb is this: Only if it leaves you in a better financial position over the long term should you enter into a refinance. An example of that type of situation would be if your original mortgage loan had an adjustable interest rate. Refinancing your loan and keeping the amount close to what you currently owe in order to obtain a fixed and reasonable interest rate is a good investment. In that circumstance, you maintain your current equity and save money on interest, money that can then be put back into your home.
Anything that goes up must come down. When real estate prices in your area go up exponentially, so then does the value of your house and your equity in it. But the reverse is also true. When the market value falls, so does your equity. However, the mortgage holder's equity is always the current principal owed by you. Rather than relying on the vagaries of the real estate market to increase your equity, take a proactive approach, invest in your home and reduce that balance line.
Some helpful info here in that What is a Cash Advance explains very well what actually could be a cash advance and how you can apply.
Andre Perry