Low-rate loans not always the most affordable
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By Scott Sheldon  May 23, 2014 12:00 am

Other factors beyond the rate can drive up a your projected new monthly mortgage payment. Such adjustments include private mortgage insurance (PMI) and the term of the loan sought. A lower-rate loan adjusting for mortgage insurance and a shorter term debt structure will make for a higher payment.

Mortgage lingo to know

• PMI: Private mortgage insurance also known as simply just MI (mortgage insurance) is the cost imposed by the lender if you have less than 20 percent equity when purchasing or refinancing a house. This can add up to several hundred dollars per month on a monthly mortgage payment beyond principal, interest, taxes or insurance. The less down payment, the higher the monthly payment, conversely, the opposite holds true.

The mortgage insurance amount can vary based on: loan program i.e. FHA loan, conventional loan, USDA loan; amount borrowed; loan to value; and credit score.


• Term: The total amount of months it takes to pay off the mortgage in full from the time the loan funds until the payoff. Take a 30-year fixed rate mortgage, for example. It takes 360 months to pay off the debt.  The longer the term the lower the payment, but the more interest paid over the total life of the loan. The shorter the term the higher the payment, and the less interest paid over the total loan life. If your objective is to get an affordable mortgage payment, interest rate may not be the best driver of reducing payment so much as taking into consideration the loan term and mortgage insurance, if it applies.

What’s the comparison for a loan backed by FHA to standard conventional loan? An FHA-insured loan is one of the most pricey types of standardized mortgages available in the market today. These loans have an upfront mortgage insurance premium, which commonly is financed (however can be paid upfront with cash at closing). This adds an additional layer of premium to the mortgage over the loan life. The percentage amount of this is important to remember. A whopping 1.75 percent of  the loan amount is what will be calculated when determining what your principal and interest payment is based of. Additionally, there is a monthly  mortgage insurance premium based on 1.35 percent of the loan amount.


• Conventional alternative: Assuming all other factors constant, a $400,000 priced home requires a slightly higher down payment and an extra 1.5 percent more in down funds in exchange for a slightly higher interest rate.

However, there is no upfront mortgage insurance premium and the monthly premium is based on .54 percent of the loan amount for total reduction of $239 per month.  In other words, for a slightly higher down payment, you could have a loan with lower mortgage amount for the same sales price. The interest rate is higher, but the payment itself is lower, thus is making the loan more manageable analyzing overall household finances.

Short-term mortgages can be a double-edged sword. Plan on paying twice the amount on a monthly basis than what you would otherwise pay on the standard 30-year fixed rate program. This coincides with the amortization term that a payment based at 360 months is going to be substantially lower than a payment based on half the amount of time, thus reversing course to pay off the balance sooner.

Looking  at our 30-year fixed-rate loan amount of $386,000 assuming interest rate 

at 4.5 percent, a principal and interest payment is $1,925 per month. Compare that against a 15-year mortgage at 3.25 percent, a principal and interest payment is $2,712 per month. The sum of $787 per month represents the additional monthly prepayment  going to principal in exchange for being mortgage free in 180  months.

Shorter-term loans, such as a 15-year fixed rate mortgage, and or even a 10-year fixed-rate mortgage offer lower rates than the traditional 30-year counterparts and rightfully so. These mortgages are typically harder to qualify for because more income is needed to offset a higher payment, catering to a stronger credit type consumers. Additionally because the loan is being paid off faster, the investor returns are greater because of decreased payoff risk. Wall Street has a greater appetite for these financing types than 30-year mortgages, which are typically refinanced or paid off every five to seven years.

By using payment as the driver to decide mortgage program rather than rate, a consumer in the market for a mortgage could better manage the payment for longer-term sustainability.


Scott Sheldon is a local mortgage lender, with over six years of experience helping people purchase and refinance primary residences, second homes and investment properties. Visit him at www.sonomacountymortgages.com.



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