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How to Pick the Best Amortization Period for Your Mortgage

How to Pick the Best Amortization Period for Your Mortgage

Are you researching the perfect home for your family? Maybe you’ve already looked at dozens of homes for sale online and have a good understanding of what type of properties interest you. Good! Now it’s time to think about how to finance it!

Smart first time home buyers (and second-time buyers for that matter) can get started with a mortgage pre-approval. Pre-approvals are important for several reasons:

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  • You’ll save time by visiting/viewing homes that you can afford.
  • Real estate agents and sellers typically only want to work with pre-approved buyers.
  • Sellers will take your offer more seriously – any offer coming from you is viewed as legitimate.

One of the key questions that you will need to answer is: How long do you want to take to pay back the home loan? Do you want to pay if off fast and live debt-free or spread payments out? It all comes down to the amortization period.

The amortization period is simply the amount of time that it takes to pay off a mortgage. Currently, in the United States, the maximum amortization period that banks offer is 40 years (for government-backed mortgages like FHA loans and VA loans).

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How does my mortgage term affect my monthly payments?

Lenders offer more than one option. You have a wide array of choices. In fact, mortgage terms can be set as 5, 10, 15, 20, 30 all the way up to 40 years.

  • Longer amortization periods decrease the amount you’ll need to pay each month. That’s the good news. The bad news is that a longer loan amortization periods increase how much you’ll pay the bank in mortgage interest.
  • Shorter amortization periods cost the homeowners less. For two reasons. First, Banks offer lower interest rates for mortgages with shorter terms because the money they lend to you is tied up for a shorter period of time. Compressing a mortgage term into a shorter duration also means you’ll pay less interest.

What amortization period should I use?

Glad you asked. There are two ways to evaluate this decision.

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First, as mentioned above, longer terms mean you’ll have a lower mortgage payment. As payments are spread out, less is needed each month to meet your monthly mortgage obligation. And home affordability is based, in part, upon your monthly income (lenders make a calculation called a debt-to-income ratio) compared to your expected mortgage payment. Therefore, lower payments translate into a bigger home. That’s a very appealing option for young families.

Shorter amortization periods decrease how much you’ll pay in interest. You’ll pay off the home faster and save money (less interest). While a buyer would qualify for a smaller home should he or she chose a shorter term, saving money can be quite appealing. You’ll certainly have more cash to diversify and invest elsewhere.

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Make a decision based on your personal financial plan.

30-year mortgage terms are the most popular option. That’s because people love bigger homes; folks tend to choose more square footage above all else. Longer terms tend to be more forgiving for first-time homebuyers who want a bigger home to “grow into” with their family.

Conversely, people obsessed with saving money tend to choose shorter terms and smaller homes. Here’s another reason to choose a shorter term: if you are over 40 years old and want to retire debt-free, carrying a mortgage for 30 years will not make that possible. Older homebuyers may want to plan ahead and choose a 15-year or 20-year term.

Clearly, you should choose a mortgage term based on your preferences. It’s important to know the difference between a longer and shorter amortization period. Armed with an understanding of the tradeoffs, you’re in a better position to make a choice that matches your style; carefully draft your future goals to make the best selection based on the kind of financial future you envision.

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Published on September 17, 2018

How Being Smart With Your Money Leads to Financial Success

How Being Smart With Your Money Leads to Financial Success

Achieving financial success is not something that just happens. Maybe if you win the lottery or something, but for the average person like you or me, it comes from a series of small steps you take over a long period of time.

With each step, you form a new smart money habit. And with each smart money habit, you build towards financial independence.

So what sort of habits can you form to get on that path? Let’s take a look at smart money habits you can start today to get you closer to a financially independent future.

1. Avoid being “penny wise but pound foolish”

It’s tempting to try saving a couple cents here and there when buying small items. However, that’s not where the real money is saved. You’re putting in extra effort for something that doesn’t move the needle.

You get the most bang when you’re able to cut down on your bigger bills. For example, finding a lower interest rate for your mortgage could save you $50+ per month. And cutting your transportation bill by purchasing a cheaper car or taking public transportation can provide large gains as well.

So, look at your recurring expenses such as housing, transportation, and insurance, and see where there’s wiggle room. It’s a much better use of your time than trying to pinch pennies here and there on smaller purchases.

2. When you want something big, wait

Impulsivity can get you in trouble in most aspects of life. Finances are no different.

It’s human nature to see something and want it right then and there. It starts as a kid in the checkout line at the grocery store, and it continues on through adulthood.

We get an idea in our head of something we want, and it’s hard not to go out and get it right then.

A good example is wanting a new car. Perhaps you’ve had your car for several years. It’s crossed the 100k mile mark. Maybe maintenance is due, and you’re annoyed that you need to replace the timing belt or purchase new tires.

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So, you get the itch.

You start digging around online, and you realize you could trade in your current car for something newer and more exciting… all for a few hundred bucks a month. Then you get obsessed.

Here’s where you have to take a step back.

Your newfound obsession is clouding your judgement. Rather than giving into the impulse, wait it out.

Set a timeframe for yourself. Maybe you come back to the decision three months down the road. See if the obsession lasts.

It might, but often, a funny thing happens. Often, you forget about it. And often, you find that the new car wasn’t a need at all.

The impulse faded. And you just saved yourself a ton of money.

3. Live smaller than you can afford

You finally get that big raise. And you want to celebrate – and why not?

You’ve been looking forward to this forever. And after all, it was all due to your hard work.

That’s fine, splurge a little. However, make it a one-time deal and be done.

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Don’t get caught in the trap that just because you’re now making more money, you should spend more.

Too often, people get more money and feel like they that gives them the means to buy a bigger house, a bigger car… you know the drill. Resist.

The fact is that living smaller than what you can afford is one of the fastest ways to build savings.

But if you constantly upgrade as you begin to make more, then you’ll never get ahead. You’ll just build up more debt along the way and have just as little wiggle room as before.

4. Practice smart grocery shopping

Food… it’s one of the biggest portions of any budget. And if you’re not careful, it can be one of the biggest drains on your wallet.

But luckily, there are a few things you can do to ensure that you stay smart with your money when buying groceries.

Create a grocery budget

Set a strict weekly grocery budget. When you know how much you can spend on groceries, you can then plan your weekly menu around it.

Once you know what all you need, you can go shopping and keep a running tally as you shop to ensure you’re on track.

I tend to do this in my head, rounding for each item. However, writing it down as you go would probably work best for most people.

Make a list… and never deviate

Never go to the grocery store without a list. If you go to the store with a ballpark idea in mind, you don’t have a true ide of what you need.

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You’re not well-researched. You don’t know what the sales are. As a result, you’re going to make decisions on the fly.

These impulse decisions will lead to overspending, which will derail your grocery budget.

Eat before going grocery shopping

It’s also important to eat prior to going to the grocery store. Hunger is a powerful force.

If you’re shopping on an empty stomach, everything is going to look good. In particular, you may find a lot of ready-made, processed snacks will look enticing.

After all, you’re hungry now and that food is easily available. So subconsciously, you may lean towards those items.

Unfortunately, not only are those items typically less healthy, but they’re likely more expensive. You pay for convenience.

However, when you eat prior to shopping, then you’ll shop with a clear mind. Your hunger won’t cloud your judgement, influencing you to make poor decisions like a cartoon devil resting on your shoulder whispering in your ear.

This makes it much easier to stick to your grocery plan.

5. Cancel your gym membership

Now that you’re all set on your food, it’s time to get smart about managing your budget in terms of physical fitness. And let’s begin by avoiding the gym. The gym bill, that is.

The average gym membership costs around $60 per month. That’s $720 a year.

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Yet, two out of three gym memberships go unused. That means two-thirds of people who have a gym membership are literally giving away almost a thousand bucks a year. It’s crazy!

I recommend seeking an alternative. One good alternative is to look into fitness streaming services.

Streaming services allow you to stream hundreds of workouts like Insanity and p90x, right in your own home for around $10-20 a month. That’s $40-50 less a month than the average gym membership.

Of course, then there’s the free option. The internet is full of free workouts that you can do on your own with minimal or no equipment.

For example, there’s the Couch to 5K program, that I personally used a decade ago to ease myself from couch potato to running my first 5K race. If I could do it, anyone could.

Then there are free resources like reddit that have limitless information on workouts. The Fitness subreddit has done all the research for you, populating workout tips and detailed workout routines for anyone to use in their wiki.

There are several routines that require no equipment. And you can join in on the subreddit to become part of the community, making it easier for those seeking comraderie and encouragement in their fitness goals. All for free.

It’s baby steps… And baby steps can start now!

I’ve never met anyone that can’t stand to be a bit smarter with their money. And on the flip side, anyone can get smarter with their money. But remember, it doesn’t happen all at once.

Begin by fighting your impulses. Prepare for the week and be smart at the store. And cut monthly expenses like gym memberships that are overpriced and you probably aren’t getting your money’s worth out of anyway.

The devil is in the details. And the details can change your lifestyle and prep you for a financially independent future.

Featured photo credit: Unsplash via unsplash.com

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