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A Guide to Home Loans for Bad Credit

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

Home Loans For Bad Credit

It may not come as a surprise that buying a home can be challenging for people who have bad credit, especially with the new median credit score required to qualify for a new mortgage slowly rising. Lenders like to see high credit scores because it exhibits the borrower’s ability to manage debt, make on-time payments and use their credit responsibly. Even though these things will come into question when a person with poor or bad credit applies for a home loan, they don’t have to let their score hold them back from homeownership.

This guide will review how bad credit can affect your ability to get approved for a home loan, available home loan options for bad credit and tips for improving your score.

PART I: Home Loan Options For Borrowers with Bad Credit

Conventional Loans for Bad Credit

 Credit Score RequiredDown payment RequiredMortgage InsuranceFees/Fine Print
FHA loans5803.5% (10% for buyers with a credit score less than 580)
RequiredUpfront mortgage insurance
Fannie Mae HomeReady®
program

620
3%Required, but can be canceled once borrower’s home equity reaches 20%
Homeownership education: $75
USDA loansNo minimum credit score0%
Required
Origination: 1-2%; Guarantee fee: 1%; Annual fee: .35%
VA loansNo minimum credit score
0%, unless specified by lender
Not requiredFunding fee varies

FHA loans

Homebuyers turn to government-backed Federal Housing Authority (FHA) loans for many reasons, particularly the low down payment and acceptance of applicants with a low credit score. There is no minimum income requirement, but lenders do want to see that the borrower can afford his or her monthly mortgage payments, if approved.

FHA loan requirements include:

  • A minimum credit score of 580
  • The property must be buyer’s primary residence
  • The property must meet standards outlined by the U.S. Department of Housing and Urban Development (HUD)
  • A down payment of 3.5%; 10% if credit score is lower than 580

If an FHA loan seems like the best option for you, the lender tool on the HUD website can help you find an FHA-approved lender.

VA loans

VA loans carry more relaxed requirements than conventional loans. Backed by the U.S. Department of Veterans Affairs, VA loans are offered to active-duty service members, veterans and their spouses who wish to purchase a condominium, a single-family home, a co-op or a manufactured home. What makes this a great choice for those with bad credit is that there is no minimum credit score or down payment required, unless specified by the lender.

VA loan requirements include:

  • A certificate of Eligibility (COE) to confirm that the buyer is a veteran or an active duty service member
  • The property must be buyer’s primary residence
  • A debt-to-income ratio (DTI) of no more than 41%

Buyers can can contact lenders directly to determine if a VA loan is an available option.

USDA loans

Created by the U.S. Department of Agriculture, USDA loans can be used to purchased property in areas defined as suburban or rural areas across the country. This option is often considered by those who will likely be denied traditional financing because of their low credit score and income. When applying for the USDA loan, applicants are not required to make a down payment, can have closing costs included in the loan and may not be required to have a minimum credit score, unless specified by the lender.

USDA loan requirements include:

  • The property must be the buyer’s primary residence
  • Positive payment history on accounts
  • A very low to moderate income
  • The property must be located in a USDA-eligible area
  • A reliable, verifiable source of income for at least the last 24 months

To find a lender who offers USDA loans, borrowers can review the recent list of approved USDA lenders or contact a specific lender directly to see if it offers this type of loan.

Fannie Mae HomeReady® program

The Fannie Mae HomeReady program is an option for first-time homebuyers as well as repeat buyers. The low down payment of 3%, which can be paid for using grants, a gift, cash-on-hand and Community Seconds® (a subordinate mortgage used in connection with a first mortgage delivered to Fannie Mae), cancellable mortgage insurance and acceptance of low credit scores make this an option to consider.

Fannie Mae HomeReady requirements include:

  • A credit score of 620 or greater
  • A low to moderate income
  • Completion of homeownership education
  • The home must be located in a low-income Census tract area

Buyers can speak to specific lenders to determine if they offer the Fannie Mae HomeReady loan.

Manufactured Home Loans For Bad Credit

Manufactured homes are built in factories then transported to a site where they are permanently affixed to a chassis. Many people who are interested in purchasing this particular type of home turn to financing to cover the cost, whether it is through a bank, credit union or the manufactured-home retailer.

As with purchasing a traditional residential property, those with bad credit have a reduced chance of getting approved for a manufactured-home loan, but there are options that are available to them.

 Credit Score Required
Down payment Required
Mortgage Insurance
Fees/Fine Print
FHA Title I
No minimum credit score
5% (10% if credit score is 500 or lower)
Required
N/A
FHA Title II5803.5% (10% if credit score is 580 or lower)
Required
N/A
Chattel Loans
Varies based on lender
Varies based on lender, but 5% is common
Varies based on lender
N/A
Fannie Mae HomeReady program
6203%Required until buyer’s home equity reaches 20%
Homeownership education: $75
USDA loansNo minimum credit score
Not requiredRequiredOrigination: 1-2%; Guarantee fee: 1%; Annual fee: .35%
VA loans
No minimum credit score
Not required, unless specified by lender
Not required
Funding fee varies

FHA

FHA loans can be used not just to purchase a manufactured home, but also the lot where the manufactured home will be located. When opting for this type of financing, there is a maximum loan amount that varies based on what you are purchasing. For example, if you are only buying a manufactured home, the loan maximum is $69,678, but if you are purchasing the home and the lot, the loan maximum is $92,904. If a buyer does not wish to purchase a lot, he or she can lease, but the lender must have an initial lease term of three years.

FHA loan requirements for the purchase of a manufactured home include:

  • The ability to cover the minimum down payment
  • The home must be used as the primary residence
  • The home’s site must meet local standards
  • Sufficient monthly income to cover cost of the mortgage
  • The home must meet the Model Manufactured Home Installation Standards.

Local manufactured-home retailers can provide borrowers with a list of lenders that offer FHA loans, or they can use the lender tool available on the HUD website.

VA

VA loans are always a great option for veterans and active duty service members who don’t have the best credit or the cash to cover a down payment. If you plan to purchase a manufactured home using a VA loan, you will encounter similar eligibility requirements as those who opt for traditional residential properties, as well as a few additional requirements.

VA loan requirements for the purchase of a manufactured home include:

  • A certificate of Eligibility (COE) from the military
  • Payment of a VA funding fee
  • The home must be affixed to a permanent foundation
  • The home must be considered real estate, rather than personal property

Conventional

Conventional loans can be used to purchase manufactured homes that will be the buyer’s primary residence or second home. The home will be used as collateral for the borrower to secure the loan, and a down payment of at least 5% is often required.

Conventional loan requirements for the purchase of a manufactured home include:

  • The buyer must own the land where the home is located
  • The home cannot have been built on or before June 15, 1976
  • The home should be at least 12 feet wide, with no fewer than 600 square feet of living space
  • The home must be connected to utilities

USDA

USDA loans can be used for the purchase of a manufactured home as well as the lot where the home will be located. Although the home is manufactured, the buyer is still expected to live in a rural area, just as those who choose to purchase a site-built home using this type of loan are.

USDA loan requirements for a manufactured home include:

  • The home must be affixed to a permanent foundation
  • Must purchase a site that is located in a rural area
  • The site must have both adequate water and sewage systems
  • If considered a single-wide, the manufactured unit must be at least 12 feet wide, with no fewer than 400 square feet of living space
  • If considered a double-wide, the manufactured unit must be at least 20 feet wide, with no fewer than 400 square feet of living space
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PART II: Ways to Clean Up Bad Credit Before Applying for a Home Loan

With your credit score heavily affecting the total cost of your loan, you’ll want to clean up your bad credit before you apply for any type of home loan. By taking several steps, you won’t just boost it, you’ll save money, too. For example, if you can increase your credit score from the 620-639 range to somewhere between 640 and 659, you can lower your APR by nearly half a percentage point and save around $70 monthly on your mortgage payments.

Tips to improve your credit score

A low credit score can hold you back from getting a home loan, but you don’t have to be stuck with your current score. If you want to improve your credit score before applying for a home loan to increase your chances of approval, there a few different things you can do.

  • Pay down existing debts: Your credit score can drop or rise based on how much debt you currently have and when you make payments. As you pay down your debt, you will increase your score.
  • Pay your bills on time: Payment history is a major part of determining your credit score, so paying your bills on time can mean a score increase.
  • Avoid applying for new credit: Applying for new credit will result in a hard inquiry on your credit report, which can cause your score to drop.
  • Keep old credit accounts open: Keep old accounts open because closing one will shorten the length of your credit history and bring down your score.
  • Address discrepancies on your credit report: It is not unheard of for people to discover inaccurate information on their credit reports, so a thorough review of your report could help you correct any discrepancies that may be bringing down your score.

Getting a mortgage after bankruptcy or foreclosure

Bankruptcy has its benefits, but when a person files, his or her credit score is likely to drop. Even after their bankruptcy has been “discharged,” releasing the debtor of his or her responsibility for the debts, the filer can expect it to remain on his or her credit report for at least seven years, and possibly up to 10.

If you have a bankruptcy filing on your credit report, before applying for a mortgage it might be better to wait until it is removed from your report and work on increasing your score in the meantime, but this not always what people decide to do.

If you choose to apply for a loan before your bankruptcy has been removed from your report, conventional loans and government-backed loans are still an option. You may have to wait a specified amount of time after the bankruptcy has been discharged, which varies based on the type of bankruptcy filed and the type of loan you plan to secure.

For example, someone who has filed a Chapter 7 liquidation will have to wait four years if he or she wants to apply for a conventional home loan. Someone who has filed for Chapter 13 will have to wait one year if he or she wants to apply for an FHA loan. If foreclosure is the cause of the bankruptcy, this can extend the waiting period. However, if the bankruptcy was due to an extenuating circumstance, such as divorce, illness or job loss, buyers may be able to get the waiting period shortened and find a lender that will work with them.

Improve your shot at approval even if you have bad credit

If your credit score is poor and you still wish to apply for a loan, there are things you can do to improve your shot at approval.

  • Put down a bigger down payment: A bigger down payment means you’ll have to borrow less money for the purchase of your home, and with a smaller loan amount, you might get approved.
  • Explain your low credit score: Certain information that appears on your credit report that drags down your score, such as a missed payment that your creditor reported, can be explained or disputed by adding a statement to your report that lenders can see when they pull your credit report.
  • Get your rent payments reported to credit bureaus: Your rent is a monthly bill that can be reported to the credit bureaus and increase your credit score, but this can only help if you have a positive payment history.
  • Decrease the loan amount: Someone with bad credit may have trouble getting approved for a $200,000 loan because it may appear to a lender that he or she can’t afford the monthly mortgage payments due to heavy debt, but if the borrower finds a less expensive home and applies for a loan for $100,000, he or she will be seen as less of a risk to the lender.

PART III: Additional resources

Renting vs. Buying

People often question whether renting or buying is the better option. When making this decision, you’ll want to look at things like your credit score, annual income and monthly expenses to determine which option is the most affordable for you at the current time. Although there are many factors to consider when deciding if you should rent or buy, if you have poor credit, continuing to rent may be the smartest move because it will give you more time to increase your score as well as your chances of getting approved for a home loan.

Watch out for scams that target low-credit homebuyers

When people are desperate to become homeowners, they can easily fall victim to scams, specifically email phishing. For many years, homebuyers have been targeted by fraudsters pretending to be their real estate or settlement agent in order to get the buyer to pay them money that was meant for their closing costs. Buyers receive an email informing them of a change that affects their closing process and how they must pay closing costs. It states that the buyer must wire the funds rather than pay closing costs using a check, but if the money is sent, the fraudster receives the cash, not the correct party.

To avoid this scam, potential homebuyers should not send any personal information or money. They should ensure they have a clear understanding of their lender’s closing process, call their real estate or settlement agent after they receive an email regarding any changes to the closing process, and request the assistance of their bank with confirming ownership of the account where they have been instructed to wire the funds.

Email phishing is not the only scam homebuyers may encounter. Some people opt for a lease-to-own homebuying experience, but this is known to lead to trouble. Often used to take advantage of low-income buyers, a lease-to-own agreement is a way for property owners to profit from the buyer’s inability to cover the cost of repairs for the home. This particular type of agreement leaves buyers unprotected, so instead of being able to get current with payments after they have fallen behind, like a buyer who has a home loan, one missed payment can result in foreclosure. Ultimately, when the home is foreclosed on, the seller is able to collect the rent and any deposits the buyer made while they lived in the home.

To avoid this scam, homebuyers should consider screening the property owner, speaking to an attorney about the agreement and getting a home inspection to reveal any repairs and their extent, which can help them to determine if they can cover the cost of repairs as well as their monthly rent.

FAQs

Yes, but buyers cannot apply for a home loan until the waiting period has lapsed.

Yes, but when refinancing, lenders will review your credit score, so if it has improved since you first applied for your bad credit home loan, you may get a better interest rate and lower monthly payment.

Yes, when applying for a home loan, borrowers can choose to have a cosigner who will be responsible for their debt should they be unable to make their monthly mortgage payments.

No, checking your credit will not cause your score to drop because it is not considered a hard inquiry, which is what can lead to a drop in score.

When one lender has denied your loan application because of a poor credit score, you can apply for a home loan with a different lender, but this can bring down your score because each application will result in a hard inquiry on your credit report. That being said, FICO considers all credit inquiries made within a 45-day period to be only one inquiry, so it may be worth it to shop around and then make a decision based on who you think is most likely to approve your application.

Because credit scores range between 300 and 850, lenders often consider a score of 580 or lower poor or bad.

Homebuyers interested in lowering their interest rate may be offered the opportunity to purchase discount points at closing. This prepaid interest allows people to make a payment — one point is 1% of their loan amount — in exchange for the lender lowering their interest rate by a set percentage amount for every point purchased.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Kristina Byas
Kristina Byas |

Kristina Byas is a writer at MagnifyMoney. You can email Kristina here

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Mortgage

Should You Save for Retirement or Pay Down Your Mortgage?

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

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On the list of financial priorities, which comes first — paying off your mortgage or saving for retirement? The answer isn’t simple. On one hand, owning a home with no mortgage attached to it provides long term security knowing you’ll have a place to live with no monthly payment except property taxes and insurance. However, you’ll also need income to live on if you plan to retire, and how much you save now will have a big impact on your quality of retirement life.

We’ll discuss the pros and cons of whether you should save for retirement or pay down your mortgage, or maybe a combination of both.

Pros of paying down your mortgage vs. saving for retirement

The faster you pay your mortgage off, the sooner you own the home outright. However, there are other benefits you’ll realize if you take extra measures to pay your loan balance off faster.

You could save thousands in long-term interest charges

Most homeowners take out a 30-year mortgage to keep their monthly payments as low as possible. The price for that affordable payment is a big bill for interest charged over the 360 payments you’ll make if you’re in your “forever” home.

For example, a 30-year fixed $200,000 loan at 4.375% comes with a lifetime interest charge of $159,485.39. That’s if you never pay a penny more than your fixed mortgage payment for that 30-year period. Using additional funds to pay down your mortgage faster can significantly reduce this.

Even one extra payment a year results in $27,216.79 in interest savings on the loan we mentioned above. An added bonus is that you’ll be able to throw your mortgage-free party four years and five months sooner.

You’ll build equity much faster

Thanks to a beautiful thing called amortization, lenders make sure the majority of your monthly mortgage payment goes toward interest rather than principal in the beginning of your loan term. Because of that, it’s difficult to make a real dent in your loan principal for many years. You can, however, counteract this by making additional payments on your mortgage and telling the lender to specifically put those payments toward your principal balance instead of interest.

Not only do you pay less interest over the long haul with this strategy, but you build the amount of equity you have in your home much faster. And to homeowners, equity is gold — you’re closer to owning your home outright, and equity can also be a resource if you need funds for a home improvement project or another big expense.

You can access that equity as your financial needs change by doing a cash-out refinance or by taking out a home equity loan or home equity line of credit (HEL or HELOC).

You won’t lose your home if values drop

When you contribute extra money into a retirement account, there is always the risk that you’ll lose some or all of the money you invested. When you contribute money to paying off your mortgage, even if the values drop, you still have the security of a place to live, and are increasing the equity in the home, no matter how much it’s ultimately worth.

Making extra payments ensures you’ll eventually have a debt-free asset that provides shelter to you and your family, regardless of what happens to the housing market in your neighborhood.

Cons of paying down your mortgage vs. saving for retirement

There are some cases where paying down your mortgage faster might actually hurt you financially. Before adding extra principal to your mortgage payments, you’ll want to make sure you aren’t doing damage to your financial outlook with an extra contribution toward your mortgage payoff.

You might end up paying more in taxes

The higher interest payments you make during the early years of your mortgage can act as a tax benefit, so paying the balance down faster could actually result in you owning more in federal taxes. If you are in a higher tax bracket in the early (first 10 years) of your mortgage repayment schedule, it may make sense to focus extra funds on retirement savings, and let your mortgage interest deduction work for you. Of course, everyone’s tax situation is different, so you’ll have to decide (with help from an accountant ideally) if it makes sense to itemize your taxes in order to claim mortgage interest payments as a deduction.

You won’t get to enjoy the return on your paydown dollars until you sell

The only real benchmark for figuring out the value of paying down your mortgage is to look at how much equity you’re gaining over time. However, the equity doesn’t become a tangible profit until you actually sell your home. And the costs of a sale can take a big bite out of your equity because sellers usually pay the real estate agent fees.

Home equity is harder to access

The only way to access the equity you’ve built up is to borrow against it, or sell your home. Borrowing against equity often requires proof of income, assets and credit to confirm you meet the approval requirements for each equity loan option. If you fall on hard financial times due to a job loss, or are unable to pay your bills and your credit scores drop substantially, you may not be able to access your equity.

Pros of saving for retirement vs. paying down your mortgage

Depending on your financial situation and savings habits, it may be better to add extra funds monthly to your retirement account than to pay down your mortgage. Here are a few reasons why.

You may earn a higher return on dollars invested in retirement funds

The growth rate for a stock portfolio has consistently returned more than housing price returns. The average return in the benchmark S&P stock fund is 6.595% for funds invested from the beginning of 1900 to present, while home values have increased just 0.1% per year after accounting for inflation during that same time period.

Assuming your portfolio at least earns 7%, if you consistently invest your money into a balanced investment portfolio, you can expect to double your money every 10 years. There aren’t many housing markets that can promise that kind of growth.

Retirement funds are generally easier to access than home equity

Retirement funds often give you a variety of options for each access, with no income or credit verification requirements, and only sufficient proof of enough funds in your account to pay it back over time. For example, a 401k loan through the company you work for will just require you to have enough vested to support the loan request, and sufficient funds left over to pay it off over a reasonable time.

Just be cautious about making a 401k withdrawal, which is treated totally differently than a loan. You aren’t expected to pay it back like you would a 401k loan, but you could get hit with taxes and penalties.

Cons of saving for retirement vs. paying down your mortgage

You’ll need to weather the ups and downs of the market

Most people who have invested money in the stock market or tracked the performance of their 401k over decades have stories about periods when the value of those investments dropped substantially. While the 7% return on investment is a reliable long term indicator how much your retirement fund might earn, the path to that return is hardly linear.

For example, if you were considering retirement between 1999 and 2002, you may have had to delay those plans when the S & P plummeted over 23% in value in 2002. If you look at each 10-year period since the 1930s, every decade has been characterized by periods of ups and downs.

Calculating the benefit of paying down your mortgage vs. saving for retirement

If you’re torn as to what to do with that extra cash or windfall, let’s look at an example of someone who has an extra $200 to put into either their nest egg or their mortgage each month for the next 30 years.

For this scenario, we’re going to assume their retirement account earns an average 7% rate of return and that their mortgage loan balance is $200,000.

Here’s how much they’d save:

Savings From Paying $200 per Month Down on Your Mortgage
Years PaidMortgage Interest SavingsExtra Equity in HomeTotal Interest Savings and Equity Built Up
10 years$6,040$30,039$36,079
20 years$28,529$76,529$105,058
22 years 6 months$50,745$200,000$250,745

One thing you may notice about the mortgage savings chart — it includes how much extra equity you’re building. Often only the mortgage interest savings is cited when people look at how much you save with extra payments, but that ignores the fact that you’re building equity in your home much faster as well. So not only do you save over $50,000 in interest with your extra contribution, you replenish $150,000 of equity that was used up by your mortgage balance.

As you can see, adding that extra $200 to their mortgage principal each month saved them about $200,000 in the long haul — but the real savings don’t stop there.

By adding an extra $200 to their mortgage payment each month, this borrower turned their 30-year loan into a 22-and-a-half year loan and became mortgage debt-free seven years faster.

That means, in addition to saving $50,000 in interest savings and gaining $200,000 of equity, they also no longer have a mortgage payment. That frees up $998.57 per month that they can now use as discretionary income. That’s an extra $89,871 they could potentially save over that 7.5 year period.

When you add that to the $250,745.41 they saved on mortgage interest and earned in home equity, they’re looking at a total savings of $340,616.

That gives the mortgage paydown a $54,000 net positive edge over saving that extra $200 for retirement, as you can see in the table below.

Savings From Contributing $200 per Month to a Retirement Fund
Years PaidRetirement Balance
10 years$34,404
20 years$102,081
30 years$235,212

The one caveat for this retirement calculation is we assumed the saver was starting at a $0 investment balance. If they already had a healthy balance in their nest egg, they might actually come out in better shape than paying down their mortgage.

There are clearly benefits to each option, and you should consider running your own calculations with your real numbers to get the best answer for yourself.

Paying down your mortgage and saving for retirement at the same time

There’s a fair case to be made for both paying down your mortgage and saving more for retirement, but why choose? If you’re somewhat on track with your retirement savings goals, and like the idea of having your mortgage paid off quicker, you could allocate a certain amount to each.

Pick a number you feel comfortable paying to your principal every month, and then to your 401k, and put it on autopilot for a year. Any time your income increases, or you get bonuses, divide up the amount between principal pay down and retirement additions.

Let’s look at what happens if you evenly divide up your $200 per month between investing your retirement and paying down your mortgage. We’ll use the same $200,000 loan at 4.375% referenced above, and look at the lifetime results.

Savings From Paying $100 Down on Your Mortgage Until Paid Off
Years PaidInterest SavingsExtra Home EquityTotal Interest Savings and Equity Built Up
10 years$3,020$15,020$18,040
20 years$14,265$38,265$52,350
25 years$30,534$200,000$230,534
Savings From Contributing $100 to a Retirement Fund for 30 Years
Years PaidRetirement Balance
10 years$17,202
20 years$51,401
30 years$117,607

Balancing the $100 investment in both strategies still yields a six-figure retirement balance after 30 decades, a debt-free house after 26 years, and shaves off $30,000 in mortgage interest expense. If you don’t like putting all your eggs into one financial basket, this may balance the risks and rewards of each option.

Final thoughts

Looking at the short term and the long term may provide you with the best framework for making a good decision about how to spend dollars on retirement versus extra mortgage payments. Be wary of any financial professional that tells you one path is absolutely better than another.

Having a stable source of affordable shelter is equally as important as having enough income to live when you retire, so a balanced approach to paying down your mortgage and savings for retirement may help you accomplish both goals.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Denny Ceizyk
Denny Ceizyk |

Denny Ceizyk is a writer at MagnifyMoney. You can email Denny here

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Life Events, Mortgage

What Is Mortgage Amortization?

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

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One of the biggest advantages of homeownership versus renting is each mortgage payment gradually pays off your mortgage and builds equity in your home. The difference between your home’s value and the balance of your loan is home equity, and your equity grows with each payment because of mortgage amortization.

Understanding mortgage amortization can help you set financial goals to pay off your home faster or evaluate whether you should refinance.

What is mortgage amortization?

Mortgage amortization is the process of paying off your loan balance in equal installments over a set period. The interest you pay is based on the balance of your loan (your principal). When you begin your payment schedule, you pay much more interest than principal.

As time goes on, you eventually pay more principal than interest — until your loan is paid off.

How mortgage amortization works

Understanding mortgage amortization starts with how monthly mortgage payments are applied each month to the principal and interest owed on your mortgage. There are two calculations that occur every month.

The first involves how much interest you’ll need to pay. This is based on the amount you borrowed when you took out your loan. It is adjusted each month as your balance drops from the payments you make.

The second calculation is how much principal you are paying. It is based on the interest rate you locked in and agreed to repay over a set period (the most popular being 30 years).

If you’re a math whiz, here’s how the formula looks before you start inputting numbers.

Fortunately, mortgage calculators do all the heavy mathematical lifting for you. The graphic below shows the difference between the first year and 15th year of principal and interest payments on a 30-year fixed loan of $200,000 at a rate of 4.375%.

For the first year, the amount of interest that is paid is more than double the principal, slowly dropping as the principal balance drops. However, by the 15th year, principal payments outpace interest, and you start building equity at a much more rapid pace.

How understanding mortgage amortization can help financially

An important aspect of mortgage amortization is that you can change the total amount of interest you pay — or how fast you pay down the balance — by making extra payments over the life of the loan or refinancing to a lower rate or term. You aren’t obligated to follow the 30-year schedule laid out in your amortization schedule.

Here are some financial objectives, using LendingTree mortgage calculators, that you can accomplish with mortgage amortization. (Note that MagnifyMoney is owned by LendingTree.)

Lower rate can save thousands in interest

If mortgage rates have dropped since you purchased your home, you might consider refinancing. Some financial advisors may recommend refinancing only if you can save 1% on your rate. However, this may not be good advice if you plan on staying in your home for a long time. The example below shows the monthly savings from 5% to 4.5% on a $200,000, 30-year fixed loan, assuming you closed on your current loan in January 2019.

Assuming you took out the mortgage in January 2019 at 5%, refinancing to a rate of 4.5% only saves $69 a month. However, over 30 years, the total savings is $68,364 in interest. If you’re living in your forever home, that half-percent savings adds up significantly.

Extra payment can help build equity, pay off loan faster

The amount of interest you pay every month on a loan is a direct result of your loan balance. If you reduce your loan balance with even one extra lump-sum payment in a given month, you’ll reduce the long-term interest. The graphic below shows how much you’d save by paying an extra $50 a month on a $200,000 30-year fixed loan with an interest rate of 4.375%.

Amortization schedule tells when PMI will drop off

If you weren’t able to make a 20% down payment when you purchased your home, you may be paying mortgage insurance. Mortgage insurance protects a lender against losses if you default, and private mortgage insurance (PMI) is the most common type.

PMI automatically drops off once your total loan divided by your property’s value (also known as your loan-to-value ratio, or LTV) reaches 78%. You can multiply the price you paid for your home by 0.78 to determine where your loan balance would need to be for PMI to be canceled.

Find the balance on your amortization schedule and you’ll know when your monthly payment will drop as a result of the PMI cancellation.

Pinpoint when adjustable-rate-mortgage payment will rise

Adjustable-rate mortgages (ARMs) are a great tool to save money for a set period as long as you have a strategy to refinance or sell the home before the initial fixed period ends. However, sometimes life happens and you end up staying in a home longer than expected.

Knowing when and how much your payments could potentially increase, as well as how much extra interest you’ll be paying if the rate does increase, can help you weigh whether you really want to take a risk on an ARM loan.

The bottom line

Mortgage amortization may be a topic that you don’t talk about much before you get a mortgage, but it’s certainly worth exploring more once you become a homeowner.

The benefits of understanding how extra payments or a lower rate can save you money — both in the short term and over the life of your loan — will help you take advantage of opportunities to pay off your loan faster, save on interest charges and build equity in your home.

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Denny Ceizyk
Denny Ceizyk |

Denny Ceizyk is a writer at MagnifyMoney. You can email Denny here

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