Sure, there are a few mathematical advantages to doing it one way or the other. And yes, those advantages may be magnified depending on your current mortgage’s interest rate. However, if you leave math out of the equation (not easy), the decision to put extra money towards a mortgage is largely an emotional decision.

More Cash or a Paid-for Home?

Imagine you had a savings account with the exact balance of your mortgage. The savings account earned 1% interest (I know I said to leave math out of it, but we’ll get to that), and your mortgage rate is 5%. Would you write a check and be mortgage-debt free, and cash poor?

My guess is you would not. I tend to agree. Again, there are mathematical advantages to paying off your morgage early. In our scenario, you are essentially paying 4 more percentage points than you are earning every year for the right to continue to borrow money from the bank to live in your home.

But by writing a check to pay off your mortgage you have essentially wiped out all of your cash. What will you do when the hot water heater breaks, or someone gets sick, or you lose your job (trust me, one of these things will likely happen if you spend 100% of your cash). Yes, there are credit cards and home equity lines (maybe) to finance smaller emergencies, but when this happens you will sure miss that cash reserve.

The Mortgage Sinking Fund Concept

Being the overly conservative person I am, unwilling to take huge risks and being quite content with a healthy emergency fund, I would probably opt to create a sort of mortgage sinking fund.

I would essentially have my mortgage payments withdrawn from that large savings account each month. I would continue to put a little extra towards the principal balance as my monthly cash flow allowed. And I would continue to build savings in other areas – a dedicated emergency fund, investments, retirement, etc.

When my other savings were sufficiently in place to handle emergencies, and my mortgage balance had been whittled down a bit through a few extra payments, then I might be comfortable writing a single check.

The main advantage to this plan is that I get to hang onto my cash reserve for a rainy day (and I mean, really pouring). I think that is a good idea with economic uncertainty becoming the new normal and probably continuing for the foreseeable future.

However, if you have a rate over 5.5% or so, it might make sense for you to consider refinancing to a lower rate, particularly if you have excellent credit and could qualify for a rate in the 4.2-4.5% range. It would probably shave a couple hundred dollars a month off your mortgage, depending on how much you’d have to borrow. Is this something you’r currently considering?

It’s been a while since I did a roundup, but I’ve run across a few excellent articles and a couple new-to-me sites over the last couple weeks and thought I’d share them with you.

The Frugal Roundup

Reader Story: Winning the Lottery. Nice to hear a story about someone receiving a windfall and not blowing it entirely. (@Get Rich Slowly)

Building Wealth Using Dividend-Paying Stocks. Tyler shares his thoughts on building wealth the slow and steady way – by investing in dividend stocks. I’m a big fan of this strategy as well, but I’m waiting on a more significant pull-back to begin investing again. (@Debt Reckoning)

4 Personal Finance Principles That Would Make Your Grandfather Proud. Thoroughly enjoyed this guest post from Baker. I often stop and asked myself – what would my grandfather do - when making financial decisions. (@Art of Manliness)

Tips for Buying Second Hand Furniture from Thrift Store/Yard Sales. A couple years ago we found a nice leather loveseat with a working reclining feature at a yard sale.  (@Balancing Beauty & Bedlam)

Ready to Invest: Types of Stock Orders. Know the difference in a market order and a limit order, and when to use one over the other? If not, read this post, which provides a nice summary of the two types of stock orders. (@The Wisdom Journal)

Frugal Fatigue. We’ve all experienced this at one time or another. I’ve found the best remedy is to budget a small splurge (with cash) and then get back after it the next month. (@Dividend Mantra)

One final note…the Frugal Dad Facebook page is approaching 3,000 fans. If you haven’t “Liked” us yet, please drop by and follow us there as well.

Anyone in debt at one time or another has faced this same dilemma, but the answer is a difficult one because there are a number of factors in play, including a number of very personal factors.

• What are you overall financial goals?
• How MUCH of this particular debt to you have?
• How long will it take to pay off this “bad” debt?
• Are there emotional strings tied to the debt that are causing problems elsewhere?

Obviously, personal opinions on what is debt (good or bad) vary considerably, too. I personally consider student loan debt a relatively bad debt, but not nearly as bad as IRS debt or debt to payday lenders.

Others consider student loan debt an investment in their future earnings, which I also tend to agree with (to a point), which is why I’d rank student loan debt somewhere in the middle.

I’m sorry to say, I experienced nearly every kind of debt prior to my financial turnaround, so I had plenty of opportunity to develop my own personal debt ranking system. Feel free to use it to motivate you towards putting together your own get out of debt plan.

The Ugly

IRS debt. Of all the “uglies” to owe money, I can’t imagine any being more ugly than the IRS. They can garnish wages without a court order, and outright ignoring them can result in jail time. Not to be messed with.

Car title/payday loans. In my town, I’ve noticed that as the economy has worsened, more cars are in the sign-your-financial-life-away-for-$200-at-300%-interest establishment parking lots. Sad.

Personal loans with baggage. By baggage I mean loans attached to bad relationships, such as owing money on a car you shared with an ex-spouse, or a personal loan financed by your father-in-law, who like to remind you how much you owe him every time you see him.

The Bad

Credit cards. Credit cards, as a tool, can be quite useful. However, credit card debt is vile. When I was deep in debt, I felt like I was working for the bank. My paycheck came in, and just as quickly as it arrived, it disappeared in minimum payments which barely cut into the balances after interest charges accumulated. It kept me awake at night, caused anxiety throughout the day, and limited my opportunities. Bottom line – being in debt sucks.

Upside down car loans. Car loans are not necessarily evil, unless you have no money to put down, buy new and drive off the lot owing more than the car is worth. Getting out of an upside car loan is not easy, so if you do finance a car purchase, consider gently used and using a trade and/or down payment to preserve some equity in the deal.

Enormous student loans. I emphasized “enormous” here because borrowing some money to finish off a degree often yields a nice return, considering college graduates usually earn more over the course of a lifetime. However, I don’t think that is an excuse to rack up over $100,000 in student load debt for a degree program in a field with starting salaries around $45,000.

Business debt. I’ve started and failed at a number of entrepreneurial efforts over the years. Fortunately, the one smart thing I did was not borrow a lot of money to finance these start-ups, so their failure didn’t haunt me for years to come. I recognize that many businesses need to borrow start-up capital to fund operations until revenues are flowing, but doing so puts the business (and employees) at enormous risk.

The (Slightly) Good

Mortgages. In a perfect world, people would be able to save up enough money to buy a home with cash. While that is certainly do-able, it isn’t practical for most of us. So, I concede that a reasonable amount of mortgage debt is not bad (and certainly not ugly).

However, as with student loan debt, the emphasis should be on reasonable. If your mortgage represents more then half your monthly income just because some “creative lender” allowed it, your home will not feel like a blessing. And you think getting out of an upside down car is tough, try an underwater mortgage.

When answering the question, “What is bad debt?” consider whether or not the money borrowed is for something that will appreciate over time. This may or may not be the case with real estate, making mortgage debt an acceptable debt in most cases.

Similarly, student loan debt is a somewhat acceptable form of debt (again, in small doses) as it often leads to higher earnings in the future.

Using that same logic, it’s easy to see why charging groceries to a credit card and not paying them off is bad debt. Three months later, the groceries are gone, but the debt is still around, accumulating interest and causing indigestion.

This post was included in the Festival of Frugality – Spend It Edition

We hear a lot about how Americans don’t save enough for the future, and how important it is to have an emergency fund for a rainy day. But we also hear a lot about the importance of getting out from under crushing credit card debt. So it’s only natural to wonder which is more important.

At first glance, you might think the answer is always “pay off debt first.” But there are a few things that you should consider before taking this advice.

1. Know Thy Enemy. Sometimes consumers do the wrong thing, for the right reasons. For example, given all the hair-raising news about eroding home equity and foreclosures, many consumers are pumping extra cash into paying off their home mortgage, rather than directing that money towards other more potentially dangerous debt like credit cards.

It is unwise to pay down your relatively low-interest, tax-deductible home mortgage, student loans, or business loans if you carry other more volatile forms of debt.

2. Break the Piggy Bank. As painful as it sounds, many times cashing in your low-interest savings account to pay off a high-interest credit card is the right choice.

Interest accruing in most savings accounts can’t keep pace with the interest accruing on a credit card account, so it is generally a wise move to raid the savings account to help get out of debt.

3. Divide and Conquer. When analyzing debt, carefully consider what motivates you the most towards repayment. Does paying interest drive you nuts? Perhaps paying off your highest interest rate card first make sense. Do you need some quick wins? Maybe you should pay off a couple low-balance cards early in your plan. However you decide to do it, figure out a way to single out one debt and make it your top priority.

Pay the minimums on your other cards until you slay the beast with the highest interest level, the highest emotional involvement (a personal loan to in-laws, for example), or the lowest balance (following the debt snowball method). Then move to the next worst offending debt and so on.

4. Know Thyself. There are two schools of thought regarding saving vs. paying off debt. One school of thought is that you should pay off the debt entirely before beginning a savings regimen. This works well until the bottom of your hot water heater gives way unexpectedly and you wind up with a hefty cleanup charge, which might lead to a credit card tailspin.

If you are the type of person who can stick with a payment plan, regardless of occasional setbacks, you should pay of your credit card debt first. If you are more likely to be derailed and disheartened by an unexpected expense, it might be wiser to focus on creating a rainy day fun, while committing to a cash-only plan for new purchases.

Once a small nest egg is built, then the attack on debt can be renewed with more confidence.

5. Hands off the Cookie Jar. In the rush to get out of debt, some people consider tapping into or liquidating their 401(k) or IRA funds. This is a poor personal finance move, since not only will you be gouged by Uncle Sam upon withdrawing the funds prematurely, you will also be losing the long-term impact of those funds on your overall financial well-being.

Some folks might stop short of cashing in their retirement funds, but instead decide to take a loan out against their 401(k). This can be a viable option for a disciplined borrower, but beware that failure to payback the loan from your 401(k) in a timely manner can result in weighty tax consequences and stiff penalties. Also keep in mind if you are laid off, or you decide to switch jobs, the loan may be due in full immediately.

For those tackling debt, how have you decided to go about it? Save first, pay off debt, or a little of both?

Shifting Views on Retirement

When I was a kid, my personal view of retirement was skewed significantly by the fact my grandfather retired from the Marines at 47, my grandmother was mostly a homemaker (particularly in her later years), and my mom was a single mom working 50+ hours a week in corporate America with no retirement in sight.

As I got older, I had friends whose parents were teachers, nurses and factory workers who had dedicated most of their adult lives to a single employer and retired from their chosen occupation. It wasn’t long before I recognized that was becoming the exception.

As our economy shifts away from manufacturing (something I personally find very sad), and into service, I think people will be more likely to change jobs dozens of times in their lifetime. I’m a bit of an exception to the rule myself. I’m in my 30s, but have worked for only two employers in my adult life (with a bunch of part-time gigs at different companies before that).

How Does this Relate to Personal Finances?

With all this job-hopping, the emphasis on personal responsibility for your financial future cannot be emphasized enough. Add in the question of social security’s solvency, the disappearance of the corporate pension, and the possibility of state bankruptcies, and you can easily see we are walking a financial tightrope with no safety net.

Younger generations must be more engaged with their finances than the “set it and forget it” generations before them. It used to be acceptable to plow all your money into 401k mutual funds and company stock. Ever heard of Madoff, Enron, or those target-date retirement funds with overly-aggressive allocations for soon-to-be retirees?

Forty year-olds with five previous employers may be sitting on five different 401k plans with bad administrators cutting into their profits with costly administrative fees. Rolling all those 401ks into an IRA might make sense, but the process can be overwhelming. And there’s always the temptation to cash out when you leave an employer – something that looks appealing, but can easily cost you nearly 40% in taxes and early withdrawal penalties. Ouch!

I’m not against 401k plans, particularly those that offer a matching contribution from employers, but if I had to choose, I’d much rather invest in a Roth IRA. Roth IRAs offer more freedom in terms of investment elections, and they offer the advantage of tax-free growth on earnings (you can even withdraw your Roth IRA contributions any time, penalty-free, in a pinch). And because Roth IRAs may be opened and maintained independent of your employment status with a particular employer, they make a lot of sense for younger generations of workers likely to bounce around the employment world before needing retirement funds.

Do I Even Want to Retire?

Back to the post from J.D; is he really retired if he still works several hours a day? I don’t think so. Has J.D. chartered a course of more personal freedom, rather than being chained to a desk eight hours a day, five days a week? Absolutely.

Perhaps we should change our definition of retirement. Or, maybe we should just expand our definition of self-employed. Were it not for a need to earn additional income, I’d say a full-time writer is mostly financially independent. That is, they no longer need to work for money to cover basic life expenses.

I believe most of us will enter a stage of semi-retirement when we get a little older. We’ll live off a combination of savings and part-time earnings, and be able to afford it by getting out of credit card debt and paying off the mortgage well before exiting full-time employment. Couple that with a frugal existence, and it wouldn’t take all that much to enjoy a lifestyle of more personal freedom.

Imagine getting to travel when most people are working. Imagine spending more time with your kids and grandkids – perhaps even homeschooling them if that is something that interests you. Imagine taking up a new hobby during the day, or volunteering more of your time. It’s all achievable, but not without some sacrifice up front.

I remind my kids, and any other young person I meet, to avoid making the big financial mistakes early on. If you do, you’ll have limitless opportunities to enjoy the next few decades of your life, while your peers will be paying for their mistakes.

If you’re like most people, buying your first home can be one of the most exciting moments in your life. From deciding which features you’d like in your new place to determining which neighborhood is the right one for you, the house buying process is an exhilarating one full of fun decisions. However, the fun generally stops when it comes to financing. Finding a way to purchase your dream home can be stressful, but getting just the right loan is one of the most important steps you’ll ever take to financial security.

While traditional loan programs often have high down payment minimums (as much as 20% of the purchase price in most cases, which translates to about $40,000 on a $200,000 purchase) and stringent credit score requirements, a government-sponsored loan program is often a great solution for first time homebuyers.

While government-backed loan programs don’t lend money directly to consumers, each program works with conventional lenders and provides each lender with a guaranty to reduce the risk of the loan. Essentially, the loan program assumes some of the risk for the loan which makes the lender able to reduce their usually strict lending requirements since the risk of exposure is also reduced.

FHA Loans

The Federal Housing Administration manages one such loan program. FHA loans are primarily for first time homebuyers and feature not only lower down payment requirements but also less stringent credit regulations. Buyers who have less than stellar credit can often still qualify for an FHA loan while not sacrificing a good interest rate, which is critical to a low monthly payment.

FHA loans feature a variety of interest rate plans and have both adjustable and fixed rates, making the program a great one regardless of your financial picture. The program allows a 3% down payment and allows buyers to roll closing costs into the loan.

VA Loans

If you’re a veteran or active duty service member who is buying your first home, the VA home loan program is worth close examination. Sponsored by the Department of Veterans Affairs, VA home loans are geared towards ensuring that those who have served our country can afford to purchase a home if at all possible.

The program features both a zero down payment option (excellent for buyers who haven’t had time to save a down payment) and a small down payment program (perfect for borrowers who need relaxed credit requirements but have saved a bit of money). Veterans and service members may use the VA loan program more than once, making it an excellent option at any stage in life.

USDA Loans

Another great government-backed loan program is the one backed by the United States Department of Agriculture. USDA loans are geared towards lower income buyers (borrowers must not exceed 80% of the median income for their particular area) and offer great payment and loan options. The USDA program just may be the only legitimate loan program remaining to civilians which offers a zero down payment option and in fact, borrowers can finance 102% of the property sale price if the home in question needs repairs. These repairs can be completed before or after the sale takes place.

The USDA program also boasts no need for private mortgage insurance, which is often required on other loans to protect the lender against default. PMI can cost borrowers up to several hundred dollars each month, so not having to pay this fee represents a huge savings to the average borrower.

Each government program has maximum loan limits to which each borrower must adhere. These limits are generally based on the cost of living in your area and are set at a very reasonable rate to ensure that every buyer, regardless of the area’s cost of living, can still afford a modest home anywhere in the country. For more information on these wonderful alternatives to traditional financing, visit your lender or visit each program’s website at www.fha.gov, www.va.gov or www.usda.gov.

Photo by sacks08

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.

*This post was included in the Carnival of Personal Finance #249 at Amateur Asset Allocator

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.

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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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.