Welcome to Fix My Finances, Yahoo Finance’s personal finance series. Each episode, we take a look at one viewer’s financial state of affairs and offer advice, insight and information on a variety of issues, including how to save more, spend less and pay off lingering debt.
In today’s episode, we meet Nate, a 27-year-old business analyst from Cleveland, Ohio. Nate bought his first home a little more than a year ago through a Federal Housing Administration (FHA) loan. He got a great rate and didn’t have to put much money down. But Nate is worried about not having much equity in his home, so he has been trying to prepay his mortgage.
Nate’s mortgage every month is $909, but he forks over an even $1,000 monthly and puts that extra $91 toward the principal of the home. Nate says he sees it as a “forced way to save” by putting money toward the equity of the home on a regular basis.
Nate also says he is actively chipping away at the principal because he is paying Private Mortgage Insurance (PMI) every month. When home buyers put down less than 20% on a home, they are required to carry PMI. Essentially it is a protection policy for the lender should a home buyer default on his or her mortgage. For Nate, PMI runs him $200 a month, and he will have to pay that until he builds up 20% of the value of the home.
In theory, paying off the principal isn’t a bad idea. But New York–based certified financial planner Stephanie Genkin says Nate should stop paying that extra money each month because he has other, more costly debt—high interest credit cards.
Nate currently owes about $8,000 on his credit cards. Because of a balance transfer, he knocked down the interest rate on half of the balance to 0% until June, 2018. (That rate will jump to 24.99% thereafter, however). But the remaining $4,000 is split among cards with rates between 10% and 25%.
In contrast, Nate’s home loan is a 30-year fixed-rate mortgage with an interest rate of 3.625%. “A mortgage is the lowest cost loan in the marketplace,” Genkin says, and Nate has “more expensive debt to fry.”
For Nate, that $100 he is putting toward his principal every month can “do more for [him] if [he uses] it to pay off [his] credit card bill,” she says. Eliminating those balances as soon as he can should be a top priority, particularly since the balance transfer card’s rate will skyrocket in a matter of months if the balance is not paid off.
Down the road
Genkin also points out that a mortgage will become cheaper over time due to inflation. For example, a salary will likely go up over time, but a payment on a 30-year fixed loan will not. “It will therefore become smaller relative to income, making it even more affordable,” she says.
So, once those cards are paid off, Nate will have more flexibility to pay off the $124,000 he still owes on his home while building up equity and working toward eliminating PMI.
But timing is everything. Nate considers his house a starter home and may not live there longer than five more years. Genkin says if he holds true to that timeframe, he should put that extra $100 somewhere else, like in an investment account where the money may do more for him.
If he is selling in five years, she says, “It seems unlikely that he will reach the [20% downpayment] before then.”
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