How To Lower Your Mortgage Payment (With Or Without A Refinance)
No matter how affordable we think our new home will be, there will almost certainly come a time when we would like to lower our monthly mortgage payments. Kids come along, or home repairs are needed, and pretty soon our monthly budget seems more aspirational than doable.
Here are some steps you can take to lower your monthly mortgage payment, but first, let’s understand the components of that payment.
What Goes Into Your Monthly Mortgage Payment?
Your monthly mortgage payment (usually) is made up of five key components. As with everything, there are exceptions to the rule, which we’ll discuss in a bit.
In the end, learning how to lower your mortgage payment comes down to simply doing the math.
Your Monthly Mortgage Payment = Principal + Interest + PMI + Homeowners Insurance + Property Taxes
These are the five categories of payment you’re making every time you make a mortgage payment. Let’s break down this formula.
What You Owe The Lender: Principal + Interest
Principal and interest go toward the home loan itself. Because of the way mortgage amortization works, in the beginning nearly all of your payment goes toward paying the interest on the mortgage, but as time goes on, more and more of it will go toward paying down the principal.
What You Must Pay To Protect Your Loan: PMI + Homeowners Insurance + Property Taxes
Your lender will require you to make certain purchases to protect the loan in the case of default. This practice reduces risk and makes your mortgage more affordable. One of these is PMI, or private mortgage insurance, which is in place on some mortgages when you don’t have 20% equity in your home.
Your lender will also require you to keep homeowners insurance in place for the duration of the mortgage. This is to ensure that, if your home is damaged, there will be money to repair it, so that its resale value is not reduced. Of course, the main benefactor of homeowners insurance is you.
While not a lender-mandated expense, your lender is also keen on making sure that you pay your property taxes. Property taxes are the only debt that stands in front of the mortgage when it comes to paying off debt.
Why Are These Extra Expenses Part Of My Monthly Mortgage Payment?
Extra expenses are included in order to protect you and your lender from the consequences if you fail to make payments directly to your insurance companies and local governments.
To make your life easier (and to prevent you from missing a required payment), most lenders offer, and often require, payments into an escrow account each month to cover insurance and tax bills. The lender will deposit that money into an escrow account, and then make the payment themselves when those bills come due. In this way, lenders can be sure that the borrower’s bills are paid in a timely fashion.
Many homeowners view this as a major convenience because it allows them to pay off their debt invisibly without the possibility of being blindsided by a property tax bill. Escrow money is always yours and if your mortgage ends with any money in an escrow account, it will be refunded to you.
An escrow waiver releases borrowers from the requirement that they include extra payments to cover insurance and property taxes. Technically, your monthly mortgage payment would go down, but you would then become responsible for paying those bills on time and in full, or face default on your mortgage (if you fail to pay property taxes).
If you’re already struggling with your mortgage payment, it might be best to think about escrow as a sort of savings account. If you fail to pay your property tax bill, you will be hit with a tax lien on your property. That will make it more complicated for you should you decide your current situation is unaffordable and you’d like to sell your home.
Rocket Mortgage® may grant an escrow waiver if you meet these requirements.
Government-backed loans from the Federal Housing Administration (FHA), Department of Veterans Affairs (VA) and United States Department of Agriculture (USDA) require insurance, taxes and their mortgage insurance fees to be paid through escrow. FHA and USDA loans require escrow for the life of the loan, while VA loans allow you to apply for an escrow waiver if you’ve had the loan for over a year and are up to date with your payments.
How To Lower Your Mortgage Payment With A Refinance
If you plan on staying in your home for the foreseeable future, and you’re currently struggling with your monthly mortgagepayment, a home refinance may make sense for you. A refinance comes with a higher upfront cost than other debt, but the long-term savings make it worthwhile.
1. Lower Your Interest Rate
If you bought your home at a time when interest rates were higher overall, or if your credit score is stronger today than it was when you applied for your current mortgage, refinancing may give you access to a lower interest rate compared to when you got your initial mortgage. It’ll just depend on whether your current mortgage is up to date and if you have a history of making on-time payments.
It may not seem like 1% could make that much of a difference, but if you have a 30-year mortgage at 4% interest, and you refinance after 3 years into a 3% mortgage, you’ll see a noticeable change.
Let’s assume you bought your house 3 years ago, for $250,000 with 10% ($25,000) down. That means that you borrowed $225,000. At 4% interest, your monthly mortgage payment – just the principal and interest for now, for simplicity’s sake – is $1,074.
After 3 years, the principal you owe on your current mortgage is $212,622. If you’re approved for a mortgage in that amount at 3%, your new monthly payment will be $846. That’s a monthly savings of $228.
Let’s say you take out that same 30-year fixed rate mortgage as described above, but now let’s assume you’ve been paying that mortgage back for 10 years. At 10 years, your remaining balance would be $177,263.91. With a new 30-year fixed rate mortgage, at 3%, your monthly payment would decrease to $747 per month, for a savings of $327 per month.
This savings on your monthly payment could be used to accomplish other financial goals.
2. Extend To A Longer Term
Note that in the above example, part of the reason for the lower mortgage payment is that you’ve refinanced into another 30-year loan. That’s because the longer you have to repay the loan, the lower your monthly payment will be. The flip side of this is that you’ll pay more interest overall for the longer repayment period.
3. Leverage A Cash-In Refinance
If you’re interested in paying down your mortgage debt as well as getting a better interest rate or longer mortgage loan term, you’ll want to consider a cash-in refinance. This is basically the same as any other refinance, except instead of taking money out of your home, you’ll be putting money into your home to reduce the principal owed. Of course, this assumes you have the money to “cash-in” to your mortgage.
In general, you can expect to pay 2 – 5% of the loan amount for a refinance. You’ll have to go through the home appraisal and title search process again as well.
How To Lower Your Mortgage Payment Without Refinancing
If the cost of refinancing doesn’t make sense for you – maybe because you’re planning to move sooner rather than later – there are other options that might yield the savings you’re looking for.
1. Make Extra Payments
If you’ve recently come into a lump sum – perhaps through a bonus, lawsuit settlement or inheritance – you can apply it to your mortgage to lower your principal and interest, which would lower your monthly payment.
Consider the debt snowflake method of reducing debt. This means you pay off your debt with micropayments from money that you find in your everyday life, whether that be from the couch cushions or a birthday check. You can make extra payments to your lender and apply them toward your principal. This won’t help much if your budget is stretched right now but, much like how several snowflakes turn into a snowball, those smaller payments can add up while also lowering your mortgage payment.
2. Eliminate PMI (Private Mortgage Insurance) Payments
If you’ve been paying your mortgage long enough to have built a loan-to-value ratio of 80% or lower, or have accumulated more than 20% of the equity in your home, you should be able to remove the PMI premiums from your mortgage payments on a conventional loan.
An Example Of PMI Costs
If your down payment for a conventional loan was less than 20%, you were required to pay PMI. On average, PMI costs between .05% – 1% of the total loan amount annually. For our purposes, let’s split the difference and assume a PMI rate of 0.75%. That means if you bought a $250,000 home with 10% down at 4%, your PMI premium probably costs around $140 per month, or $1,687 per year.
If you were to refinance after 3 years, with a balance of $212,622, your new PMI premium would be $133 – because after 3 years, you still hadn’t reached the 20% equity level, so you must continue to pay PMI. Your PMI payment would be lower than what you’re currently paying, because the balance is lower.
In the above example of a refinance after 10 years, you would not only benefit from lower interest, a lower balance and longer term – you also wouldn’t have to pay any PMI.
Once you’re well over the 20% equity requirement, you can have PMI removed from your mortgage. In fact, if you’ve noticed a lower monthly mortgage payment, it might be that PMI has been automatically removed from your mortgage.
In order to remove PMI, lenders must make sure to comply with rules set by Fannie Mae and Freddie Mac for conforming loans. In general, your mortgage will cancel your PMI on the date that you were expected to reach the magic equity level.
However, if you believe you have reached the requisite equity level – whether by making extra payments, increasing your home’s value through renovation or through appreciation of your home’s value as part of a rising tide of home values in your area – you can apply for an earlier PMI removal. Check your mortgage agreement or visit your lender’s website to learn the exact procedure to follow when making this request.
If you have a government-backed loan, either through the FHA, USDA or VA, you will pay MIP (mortgage insurance premiums), guarantee fees or funding fees instead of PMI.
With an FHA loan, borrowers who’d been able to make a down payment of at least 10% must pay annual MIP for 11 years, regardless of the amount of equity they have in their homes. Borrowers with lower down payment amounts must pay the annualized fee for the entire loan term.
3. Comparison Shop For New Homeowners Insurance
If you want to find other ways to lower your mortgage payment, you can shop around for a better deal on your homeowners insurance policy. You may have installed a new or better security system or fortified your home to better protect it from your area’s most likely natural disasters. If so, you might qualify for a reduced insurance rate.
Check with your lender to learn their procedure for swapping out one insurance policy for another. Your new plan must meet your lender’s requirements for coverage.
4. Challenge Your Property Tax Assessment
The last input that can change your monthly mortgage payment is what you pay in property taxes, which is based on your locality’s assessment of your home’s value. Many homeowners don’t realize that property value assessments can be challenged and, if successful, your tax bill could decrease.
The Bottom Line
If you’re wondering how to lower your mortgage payment, the first step is to understand what goes into a mortgage payment. Not only does this give you options but allows you to save money for other things in your life.
Ready to refinance your mortgage? Get started today from the comfort of your own home.