One of the most frequent questions I see popping up these days is whether or not we should continue to invest in stocks, or pay off our mortgages early? There are many factors driving the urgency behind this question. The down economy, and endless talks of deficit spending, national debt, etc, seem to have awakened people from their personal debt slumber. Folks are finally making serious dents in their personal debt, and I think that is a good thing.

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But what about mortgages? Real estate has been a pretty touchy subject as of late. Many people now find themselves underwater – owing more on their mortgage balance than their home is worth. Those not currently in a home have taken a much more cautious approach to home buying than just a couple years ago, when anyone who could scrape up closing costs and had a half-decent FICO score were jumping into jumbo mortgages they could ill-afford.

Now that we have seen real estate is not a sure thing when it comes to appreciation, and that the market can basically go nowhere in an entire decade, we are questioning some long-held assumptions about the world of finance. Maybe it doesn’t make since to keep a mortgage. Maybe paying off a mortgage early, and living debt free, is the ultimate hedge against what the future might hold. Maybe renting isn’t such a bad deal after all.

Using Investment Money to Pay Off Mortgage

I was recently asked by a friend if they should pay off their mortgage using $120k in taxable investment accounts. I asked him the opposite of that question. “If you owned your home free and clear would you take out a mortgage to put $120k in the stock market?” Naturally, he replied, “Of course not!” Same thing.

That question gets right to the heart of the matter: risk. Our society seems to be going through a pull back thanks in large part to the pains we’ve experienced after watching each other go on a credit binge. It goes beyond being frugal. People are downright scared. And for good reason.

Unemployment is still hovering around double digits (real unemployment is much higher). I read a new article every day about the coming bust in commercial real estate. The student loan program appears to be under strain (and might get overhauled along with the healthcare system). And will there be a double dip to this recession? There is a lot of uncertainty out there.

I often advise people to make paying off their mortgage a priority, once other financial goals such as retirement investing and saving for college are in place.  However, I’m going to go a step further. I believe, over the next decade, we are going to see some unprecedented shifts in the way our economy operates – some good, some bad.

I think those who are completely debt free will be the most insulated from the negative effects of the changes, and have the most opportunity to be successful. That doesn’t mean you’re doomed if you have a mortgage (at least I hope not, considering I still have one myself), but it does mean that finding a way to pay off your mortgage should be near the top of your financial priorities.

What About the Opportunity Costs Lost By Not Investing in the Market?

Well, assuming market values appreciate in the coming decade, there is a cost to paying off your mortgage rather than investing in stocks. However, if I asked you if you’d rather owe nothing on your home or have $150,000 in savings in ten years, which would you pick?

Not having a mortgage could mean living comfortably on $1,000 a month less (or more, depending on your home loan). With $150,000 in stocks, you are doing pretty good, but certainly no where near financial independence. And you’d still have that big mortgage payment to contend with.

In a perfect world we could do both: pay off the mortgage early and invest in the stock market. Unfortunately, most of us don’t have that many dollars to play with. So, the ideal compromise may be to save for retirement, save for college for your children, and then pay off the mortgage early, rather than invest in taxable investments outside of retirement accounts.

This is the plan I will adopt, with the exception of adding to my dividend stock portfolio over time in an effort to boost passive income.

I was recently fortunate enough to have the opportunity to interview Dale Siegel, author of The New Rules for Mortgages. We exchanged emails in a Q&A format on the subject of mortgages, the housing market, etc. Here are her responses to my questions.

Lending Guidelines

Frugal Dad: Lenders used to operate under a 28/36 mortgage-to-income/debt-to-income ratio when calculating maximum mortgage eligibility. How has the housing bubble affected those ratios for lenders?

Dale: Lenders use ratios as guidelines for qualifying a borrower for a mortgage. It is the total housing expense divided by gross monthly income and then total housing expenses plus all monthly debt divided by gross monthly income. Depending on which lender you go to, the typical ratio that lenders work with can range from 28/36 to 33/41.

Before the implosion of the mortgage industry, many lenders would push ratios upwards of 65% of the borrower’s gross (before taxes) monthly income, using compensating factors such as good credit or low loan to value. There were also products such as no income and no ratio loans which would eliminate the calculation all together and a borrower could mortgage multiple amounts of monthly income- and are behind the eight ball now!

Ratios are a guidance tool for the lender to calculate what they think a borrower should take out. However, the true number comes from the borrower themselves.  Use the mortgage amount the lender tells you you qualify for and really analyze it based on what you know about your own finances.  Make lists of your monthly income and expenses, create a 5 year plan and see what larges expenses might be coming up in the short term and think about things in life that can mess up your plans. Only the actual borrower knows what they can comfortably afford for a housing expense without compromising too much. Remember, the lender does not take into consideration things such as food, clothing and summer camp-but you should-and you can’t have it all.

Down Payments

Frugal Dad: How much (%) should homeowners aim to put down on a mortgage to secure the most favorable terms?

Dale: Down payments should be as large as you can manage: no money or little down mortgages are history-except for the FHA. Two years ago, you could get the same interest rate with 5% as you could with 25% down. Now, the lenders use a matrix consisting of FICO score and loan to value to calculate the interest rate. So, the better your FICO score, the lower your interest rate and the more equity you have in a home the lower your interest rate.

Many lenders will not allow loans over 80% now and it is harder to get PMI (Private Mortgage Insurance) for those loans. The lenders charge higher rates for scores over 620 and for loan to values over 60%. So if your credit score is 640 and you are putting down 20% your rate will be much higher than the guy that has a 720 FICO score and is putting down 30%. This is the way all lenders work now and they all go off of the same chart. So, one bank will not be better than another in this instance. What the borrower needs to understand is how the lender calculates their interest rate and they have the right to ask for the actual computation used.

FICO Scores

Frugal Dad: To qualify for the best mortgage rates, what credit score range should home buyers aim to be in?

Dale: The credit score is more important than ever now, because the lenders go off of the pricing matrix and there are no longer compensating factors used to cover a bad credit score. The score is what it is with no deviation in pricing the mortgage interest rate. As said, the lenders would do a loan with a FICO score of 500 if the borrower had other things going for them such as low loan to value, little debt or a lot of assets in the bank after the closing. Now, those things do not matter.

Most lenders will not take a loan with a FICO score under 620 and the new “good” score is currently 720. So, if your score is not over 720 you can still get a loan, as long it is not under 620-you will simply pay a higher rate. Of course there are lenders out there that will budge on that, but be careful which promises you follow.

Shopping for a Mortgage

Frugal Dad: Where is the best place to shop a mortgage for first-time home buyers? Current bank? Mortgage broker? Online?

Dale: The other day I was misquoted in the Tribune as saying do not use a mortgage broker to shop for a loan. I received hate mail from a bunch of Texas mortgage brokers and had to convince them that, being a mortgage broker myself, I did not specifically say that. What I did say was that the consumer needs to take responsibility for themselves and shop for a loan with the best interest rate themselves. I truly believe that no one is too busy, too important or too dumb to put their financial future in the hands of one person and must always be checking the information provided to them. (Think if Bernie Madoff was also providing mortgages to his chosen clients.)

When shopping for a loan, one should never use the internet as more than an educational tool. The internet is a fabulous world for loan terminology and mortgage calculators, but why would you get a mortgage from a provider that you found in cyberspace? Companies such as Lending Tree, Quicken Loans and others, are more so lead generating companies for the mortgage industry rather than direct providers. Remember free credit reports and loan qualifications come with a price tag. This price being your information is being sold to a loan officer somewhere that will hound you to get your mortgage through them.

So, now that I have told you where you should not get a loan, where should you go to get a mortgage? There are the commercial banks, such as Bank of America, Wells Fargo and the like. They are great big institutions which have lots of loans to choose from and competitive interest rates. What they also have are departmentalized loan processing systems and voicemail. So, if you have the patience to call around, shop for a rate and deal with many different people through the loan process then a large bank would be for you. Next, we have the smaller regional community banks known as savings and loans. They work just like the big banks do, but you might get more personalized service. Again, shop around and ask a lot of questions.

Third party mortgage providers are mortgage bankers and brokers-like me. Having assisted with over 65% of all mortgages obtained over the past five years, they were a big part of the real estate boom and bust that we have seen.  These companies are not the direct lenders and simply provide a service of assisting the consumer with getting a mortgage with hopefully the lowest interest rate. Their job is to shop your loan and work with you and all the parties involved from beginning to end. For this, they receive a fee from the lender your mortgage ultimately goes to. It is a win-win for all if you are working with a professional and honest broker.

The fact is that no matter what institution you get your loan from it is the loan officer you choose that should be the big decision. I believe it does not matter where I work, whether a bank or a self employed mortgage broker. It is my experience, stability and integrity that makes me a good loan officer. A consumer should choose carefully who they want to use based on a series of questions and how the loan officer handles that conversation. Think of the initial conversation with a potential loan officer as a first date. If it does not go well, why go out on a second date? There are a lot of fish in the sea!

Paying Off a Mortgage Early

Frugal Dad: We frugal people like the idea of living without a mortgage. What are your thoughts on paying off a mortgage early?

Dale: Frugal living in my book, means living within, or below your means. It means not buying that 56-inch flat panel and paying it off over time, not driving the expensive car because they offered you 0% interest rate on a 60 month loan and not going out to dinner every night of the week. Frugal living means thinking before you spend money on something you need or already have, being able to save every month and having a reserve fund on hand in case you lose your job or have an unforeseen expense.

Living mortgage free is more of a luxury for those frugal followers. Since most people cannot buy a home without a mortgage and there is a tax benefit for writing off the mortgage interest, it is not such a bad thing. In other words don’t feel that you need to buy a home for cash, pay off your mortgage as quickly as your credit card or keep renting if you cannot afford to buy a home.

Assuming one can afford the mortgage payments, I love to suggest accelerating them. One extra mortgage payment per year knocks a 30 year mortgage down to approximately 24 years and a few months. One extra payment can be made as adding 1/12 of the monthly payment to each month, paying one total extra payment to the lender each year or making a ½ payment every two weeks. Anyway you do it, it adds up to a total of 13 payments a year. The saving in interest is approximately 1/3 of the total interest for the life of the loan. Knocking off this much interest equates to lowering your effective interest rate by almost 2%! This is a huge savings for the borrower and paying it off early is a gigantic satisfaction.

Any way you want to look at it; homeownership is a luxury and is not meant for all. The American Dream is a dream not an entitlement.  A home is typically the largest single asset one owns and should fit nicely into the entire financial picture. Remember the whole is only a sum of the parts and this part should not be too big as to swallow up everything else. With times the way they are today, the consumer should be much more vigilant, diligent and responsible in their homeownership and mortgage selection. Moving forward, there were lessons to be learned by all and hopefully we will not forget what happened in the past when making future decisions.

End of interview.

I’d like to thank Dale for taking the time to answer my mortgage questions, and I wish her much success with her book. In fact, she was nice enough to send me a copy of her book, which I’ll be reviewing here at Frugal Dad in the next couple weeks.

More About Dale

Dale Robyn Siegel is a licensed attorney in New York and owner of Circle Mortgage Group, a boutique mortgage broker in White Plains, New York. She is an adjunct professor at Baruch College as well as NYU Schack Institute of Real Estate.

Dale has been speaking to the public and teaching real estate professionals about mortgage finance for the past ten years. You can learn more about The New Rules for Mortgages at TheNewRulesforMortgages.com, and you can purchase a copy at Amazon.com or visit her virtual book tour.

We are still in the midst of what most would consider a great time to buy a house. Benefits are plenty for first time home buyers and those looking to trade up alike, including sizable tax credits and low interest rates. I personally know a number of people currently renting a house that are finally considering buying a new home.

One argument used to convert renters to homeowners is a side-by-side comparison of mortgage payments to monthly rent. Realtors often like to tell potential buyers that renting is like “throwing money away.” I happen to disagree with that logic, and think renting makes a lot of sense in certain scenarios. Considering the lessons we’ve all learned from the 2008 real estate bubble, building equity is no longer a sure thing either.

Comparing rent to mortgages and declaring mortgages a cheaper option is to compare apples and oranges. Let’s assume a potential home buyer is considering two houses of equivalent square footage. One home rents for $1,000 a month. The other home could be financed with a principal payment of $1,000. Based on these two costs alone the deals look equal, however there are a number of other factors to consider.

Property taxes. One of the benefits of renting is that you are not responsible for paying property taxes on the home. The bill still comes to your landlord. Of course, if you own a home you get a tax deduction on mortgage interest, but depending on your income this may or may not be a wash.

Insurance. Homeowners insurance is practically a requirement when buying a home (in fact, most mortgages require it to underwrite the loan, and even if they didn’t it is still a good idea). Renters should investigate renters insurance as it is typically very cheap relative to the contents of your rented home. Since renter’s insurance is usually cheaper than home owner’s insurance, renters have a slight advantage here.

Maintenance/Repairs. This is the big one. Hot water heater bursts in the middle of the night and floods your utility room. Who pays for the repairs and cost to replace the water heater? If you own the home it will come from your emergency fund (hopefully). If you rent, a quick call to the landlord is all that’s required and they are on the hook for repairs.

Same for ongoing maintenance of the property. Landlords are responsible for things like painting or replacing siding on the exterior of the home, putting on a new roof, and any other updates required over the years. Renters are typically responsible for things like lawn care and keeping the interior in good shape (walls, carpet, etc.).

For this reason, it is important to have a solid emergency fund before taking the plunge into home ownership. Take it from me, if you buy a home without much in savings, something expensive will break within the first 90 days. It’s a sure bet. If it can happen, it will.

Freedom. Even though freedom is not a tangible cost of renting or home ownership, it is still a very important factor when choosing where to live. Renters typically sign a lease or rental agreement for a specified time (usually one year). Most people who buy a home sign a 30-year mortgage, and unless they pay off the mortgage early, they will be stuck with the debt for decades to come.

Guess who can pick up and move easier if the local economy sours? Guess who can move to a different part of the country if they decide the heat/cold no longer agrees with them? Yep, it is the renters. Buying a house is a big commitment, and if you are still unsure about planting roots in your community, job, etc. then it might make sense to rent a little longer.

It is a great time to buy a home with plenty of inventory, motivated sellers, tax incentives and low rates. But none of those things matter if you are not in an position to buy. Resist taking on the added responsibility, and the debt, if you are not ready.

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It’s easy for a first time home buyer to get lost in translation when swimming in the sea of mortgages. Common questions of first time home buyers are “what mortgage is right for me? What are the benefits and downsides of certain mortgages? How much will I end up paying in interest payments over the long term? How much can I expect my monthly mortgage repayment to be?” If you are a first time home buyer who is simply trying to get a brief education on the most popular mortgage, a fixed rate mortgage, I’ve got you covered. Here is an in depth, yet simple to understand, review of the fixed rate mortgage.

Steady Mortgage Repayments

Fixed rate mortgages are the most popular mortgage choice amongst home buyers known to date. Fixed rate mortgages allow for borrowers to pay their mortgage repayments on a set monthly amount that will not be subject to change over the course of the mortgage repayment process. For example, if you purchase a home today under the term of a 30 year fixed rate mortgage and your current monthly mortgage repayment is $1,400 per month, twenty five years from now your monthly mortgage repayment will be the same amount.

Interest First

The most popular fixed rate mortgage term is a 30 year term. However fixed rate mortgages are available in terms as short as ten years or as long as fifty years. The mortgage repayment structures for fixed rate mortgages are designed to primarily pay down the interest payments that were paired with the initial mortgage.  However attractive loan officers may have packaged fixed rate real estate auctions, their efforts fail to mask the biggest defect of this mortgage system. The defect is that borrowers end up paying the creditor far more than 100% of their loan’s principal in interest alone.

Sandra the Home Buyer

For example, let’s say Sandra purchases a home in January of 2009 and borrows $250,000 under a 30 year term and has been given an annual interest rate of 8%. At the end of the 30 year term, Sandra has paid a total of $660,387.60. Exactly how much of that money has gone towards interest payments? A total of $410,387.60 has gone towards interest payments; which is 164% of the principal.  Throwing around all of these numbers is probably not the most eloquent way to get my point across. In order to minimize confusion, I’ve provided a screenshot of the example.

If you enjoy the security that a fixed rate mortgage provides, you are not alone. If you are okay with paying practically twice your home’s actual worth in interest payments alone, you are sitting by yourself in an abandoned town.

Most home buyers who fall into the trap of the fixed rate mortgage fit into one of two categories. Category A) the buyer is desperate to purchase a home and has been declined by every other mortgage application aside from a fixed rate mortgage. Category B) the buyer failed to translate the 8% interest rate per year into the accumulated interest rate over the entire loan term.

Editor’s Note: Jazmin’s example represents an extreme example assuming an 8% interest rate. Current rates are far lower for borrowers with good credit, but there are still some products on the market that look a lot the old “sub-prime” mortgages with interest rates much higher. If you can’t borrow at a more competitive rate, I would submit that you cannot afford to buy a home. As Jazmin points out – it is simply too expensive. Remember, there is no shame in renting!

Jazmin Espinal is a professional freelance writer and the owner of Capital Web Writing, a web content solution for businesses and webmasters. To contact Jazmin or to see samples of her writing, please visit CapitalWebWriting.com.

Few things strike up a debate faster than asking what good is a credit score these days?  There are those who totally spurn the idea of some 3rd party determining their credit worthiness.  There are others who worship the mighty FICO, well aware of its ability to save them money on future loans, insurance, and even affect their job hunt.  I fall somewhere in the middle. Still can’t help but wonder, what good is a good credit score?

I would not suggest someone go out of their way to wreck their FICO score, but I also wouldn’t recommend people be too concerned with their credit scores, either.  For far too long we have been beholden to this score, and taken on unnecessary debt in the name of improving our standing.  If you manage money wisely, make smart decisions when it comes to debt – including the type of debt you take on, and how well you repay it – you should have no trouble securing a high FICO score.  And here are a few benefits…

Higher FICO, Lower Mortgage Payment

According to the research at Information Research Services (infomars.com), as MyFICO.com, the difference in a 620 credit score and a 760 credit score means a $197 lower mortgage payment (on a 30-year, fixed rate mortgage of $200,000).  This is based on rates as of March 27, 2009, and may fluctuate some, but you get the idea.  Having an upper-tier FICO score can lead to significant savings in interest on real estate purchases.

Not only will optimal rates be available only to those with higher credit scores, but it could mean the difference in qualifying for a mortgage loan, or having to pay additional points to secure a decent interest rate.  The mortgage industry is probably the biggest supplier of FICO worries because most of us cannot afford to pay cash for a house, so financing is our only option.

Drive Cheaper

For those who opt to finance a new car purchase on shorter terms (36 months), a FICO score greater than 719 saves you about $119 a month over those with credit scores below a 590.  Personally, I don’t plan to ever finance a car again, but if I did I would obviously want to qualify for the lowest rates possible.  Bad enough car payments are as high as they are these days, but toss on another $100 due to high interest charges and it becomes downright ridiculous.

Higher Scores Lead Better Employment?

This is an area where there just isn’t much hard evidence to support FICO’s (and much of the financial press) claim that low credit scores can affect employment.  I’m sure employers in certain industries would be interested to know your FICO score as one piece of determining your overall employment potential, but using FICO as a screening tool has so many limitations.

Credit scores don’t tell employers a thing about the level of education someone has achieved, their savings and other assets, their work ethic, their trustworthiness, etc.  For instance, I used to work with someone who had trouble finding a job in her degree field (accounting) because she had gone through a nasty divorce and her ex-husband destroyed both their credit through running up unpaid credit cards, gambling, and a host of other financial problems.

It was only when she discovered this was going on behind her back that she ultimately asked for divorce, but the damage to her credit was done, as a couple of the accounts were in both their names (her husband forged her signature as a co-applicant).  Even though what he did was a crime, it was a nightmare to get accounts removed from her report, and things continued to “pop up” for months.

Potential employers looking for someone to handle their company’s money may incorrectly toss her resume based on a low credit score, when in fact she was probably more qualified than many other candidates in terms of education, work history, etc.

I’m sure you could dig up an employer or two to own up to using FICO scores for screening purposes, but most won’t.  I’m also sure you’d be hard pressed to find anyone in the banking industry that believes is not true. Again, we’ve been oversold on FICO and its importance in our society.

Don’t get me wrong, I think there is a place for credit scoring in helping insurers and potential lenders determine the risk of a potential customer.  However, I don’t think it is fair to label people with low (or non-existent) scores as bad, as if they deserve to walk around with some type of “Scarlet Letter” reading FICO=607 on their forehead.  Credit scores are but a small piece of the overall picture of someone’s creditworthiness, and to allow it to be the lone determining factor is just plain lazy on the part of lenders.

As consumers, the onus is on us to manage our credit wisely, check our credit reports periodically, and don’t go out of our way to damage, or enhance, our FICO score.  If you find yourself in my friend’s situation, dealing with a low FICO, there are plenty of ways to improve your credit score on your own.  Do not let desperation lead you to one of these “credit repair” places who charge fees for things that you can do yourself.  The number one thing that improves your credit score is time.  Yes, it heals credit wounds, too.

Get your updated FICO score today at MyFICO.com