How Paying More Interest Could Save A Home Buyer Money

Andrew and Amanda thought they knew what I was going to say when they walked in the door.  They were looking to buy their first home, had good jobs, great credit and the ability to put 20% down.  They had already talked to a couple of other lenders before me so they were fully prepared for my recommendation.

“So we should put 20% down, right?  And probably do a 15 year loan to pay it off faster?” they asked nonchalantly.

“No….no, that’s not what I would recommend for you.  I’d only put 10% down in your case and consider the 30 year term.”

Needless to say, Andrew and Amanda were surprised.  Anyone who has worked with me before would likely be shocked as well. Why?  Because it’s well known that I’m very anti-debt.  Even though I help people get loans for a living, my goal is for my buyers to owe as little as possible for as short of a period as possible. 

So why would I encourage these buyers to borrow more and stretch it out over a longer time?

Considering The Whole Picture

Truly, there was a method to my madness.  When making my recommendation, I was just looking at a bigger financial picture than the previous lenders had considered. 

Most mortgage lenders tend to look at the new mortgage as an isolated loan when making their recommendations.  It’s not though.  This new loan is going to be a part of the buyer’s total financial picture.  As such, the full financial picture should be looked at when deciding on which mortgage options are the most beneficial.

Yes, Andrew and Amanda had the savings to put the 20% down.  They also had extensive student loans, though, most of which were at 6%-7% interest rates.  Andrew and Amanda had larger incomes which was great in that it allowed them to save money quickly but bad in that it excluded them from getting any income tax benefits on the interest paid on those student loans.

The interest rate on their new mortgage would be 2-3% lower than the student loan interest and it likely would be deductible when determining their taxable income.  Seeing it would be a cheaper source of money on multiple fronts, financially it made sense to pay more on the student loans and less on the mortgage.

But….what about PMI?

When I explained my recommendation, Andrew and Amanda immediately grasped the logic of using their extra savings to pay down the student loans instead.  The risk of Private Mortgage Insurance (PMI) concerned them though.

“Don’t we have to put 20% down?” they asked.  “Won’t we have to pay PMI if we don’t?”

“Not in your case.  For you, I would recommend a no PMI conventional loan.”

Ways To Slay The PMI Beast

No PMI?  Is there really a no PMI conventional loan with less than 20% down?  Well, technically...no.  If you don’t have a 20% down payment, someone is going to have to pay for insurance to protect the lender if the buyer defaults.  Normally that insurance is paid for in monthly installments by adding a premium to the buyer’s mortgage payment. 

That is not the ONLY way it can be paid though.  If the buyer chooses, they can pay a lump sum upfront and have no PMI for the life of the loan.  If that lump sum needed is under 3% of the price, they can also ask for the seller to pay for it in seller concessions.

These weren’t the options I proposed for Andrew and Amanda though.  Instead, I recommended lender paid PMI.

Getting Smart with LPMI

Lender Paid Mortgage Insurance (LPMI) can sometimes be the best option for PMI avoidance.  In Andrew and Amanda’s case, I could increase their mortgage interest rate by 0.125% and, with the excess lender income from that, pay the lump sum PMI in full for them.  This was a win on both fronts in that it removed a higher monthly PMI cost (not tax deductible) and replaced it with a lower increase in interest cost (wonderfully tax deductible). 

And how did this work out for them in dollars and cents?  Very nicely, actually.  The monthly PMI option would have added $108.23 to their monthly mortgage payment.  The 0.125% higher interest rate?  It only added $25.59 to the payment. 

Knowing the Downside

While this was a good option for Andrew and Amanda, this structure isn’t one I would propose for everyone because there is a downside.  The buyers going this route have to actually follow the plan we’ve made.  That means the extra that was going to go toward the down payment needs to actually go to the student loans, NOT to new furniture for the home or other optional items.  And the extra money they’ll have each month by taking a 30 year term instead of a 15 year term also needs to go to the those student loans.  If it doesn’t, they’ve taken on additional debt for nothing.

I could see that Andrew and Amanda were capable of working this plan though.  As a matter of fact, they were thrilled by it.

Paying off their student loans had been a BHAG (big hairy audacious goal) for them since graduation, and they were excited to start working on it in an intentional, mapped-out way.

So The Moral Of The Story Is…

Is there a moral to this story?  But of course!  In short, mortgages are not a ‘one size fits all’ thing.  There are multiple ways to structure a loan and a mortgage lender should be exploring all of them in light of their buyer’s big-picture finances, not just through the lens of the mortgage alone. 

If you’re considering a home purchase and want a detailed review to see what mortgage options will best benefit you, drop me an email at lori.hiscock@ruoff.com.  I wish you all the best in your home shopping adventure!

To learn more about the products covered here or any other aspects of home financing, contact Lori Hiscock at lori.hiscock@ruoff.com.  

Lori Hiscock is a Sr. Loan Officer at Ruoff Home Mortgage‘s South Bend office.  One of Michiana’s top mortgage loan officers, Lori started her lending career in 1995 after obtaining her bachelor’s degree in Finance from Western Michigan University.  You can connect with Lori Hiscock or apply online here. NMLS#404320.

Ruoff Mortgage Company, Inc. is an Indiana corporation licensed by the Indiana Department of Financial Institutions (DFI) and operates with the following licenses:

Indiana-DFI First Lien Mortgage Lending License #10994;
IL Residential Mortgage Licensee #MB.6760734;
Michigan 1st Mortgage Broker/Lender License #FL0017496.

Ohio Mortgage Broker Act License #MBMB.850220.000

The Florida Office of Financial Regulation License #MLD1182