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1% Mortgage Loans… What's The Catch?
While there are several different types of 1% mortgage loans, there are really only two major keys to winning with a 1% mortgage loan.
The first key is to make sure the loan is set up correctly from the beginning.
And the second is to make sure you are using the loan correctly to gain the most benefit.
First, let’s talk about how the loan works. Then we’ll get into how to set the loan up correctly so you can reap the financial rewards these mortgage loans have to offer.
To start with, 1% mortgage loans have payment options. Each month when you get your mortgage statement you will have the option to make a 30 year fixed payment, a 15 year fixed payment, an interest only payment and a minimum payment at 1%.
Although you are given several payment options, you should only select the 1% minimum payment.
Because if you wanted to make a 30 year fixed, 15 year fixed, or interest only payment, you would be better off getting that type of loan. Typically, these payments are higher with a payment option mortgage loan.
If you select the 1% minimum payment your first benefit will be a significant monthly payment reduction. Your mortgage payment will likely be cut in half. Of course, this is a pretty attractive first benefit for most home owners.
To compound the effectiveness of selecting the 1% minimum payment you should save what you save. For instance, let’s say you refinanced your home with a 1% mortgage loan, paid off all your credit cards, and reduced your monthly payment by $1,000 a month.
Now, if you save that $1,000 a month for yourself instead of giving it to your creditors, you will have $60,000 in cash at the end of five years - And that’s with a zero percent return.
Here’s the second benefit to selecting the 1% minimum payment option:
If you make an interest only payment your mortgage balance will stay the same. If you make a 1% minimum payment you are actually paying less than interest only. Therefore, you are creating deferred interest which makes your mortgage balance increase each month.
Before you freak out, keep in mind that deferred interest is mortgage interest and is therefore tax deductible.
Let’s say your home is going up in value $2,000 a month. The 1% mortgage loan will allow you to take a small piece of that appreciation, say $500 a month, and turn it into a tax deduction.
So you are taking a small piece of your equity each month and turning it into a tax deduction. If you did not do this, all of your appreciation would be locked up in equity.
Equity is terrific and is certainly one of the many benefits to home ownership. But investing in equity will get you a zero percent return.
No one is going to cut you a check each month for the equity in your home. As a matter of fact, if you wanted to get the equity out of your home you would have to sell your home or get a loan. And you better qualify or you will not be able to get a loan.
So why not take a small piece of your equity each month, turn it into a tax deduction, and at the same time save $1,000 a month for your self? You will still have plenty of equity but with a 1% mortgage loan you will have cash AND equity.
If you do this for any length of time you will come out way further ahead financially than if you did a regular 30 year fixed or an interest only mortgage loan.
By the way, if the deferred interest is a concern, try making bi-weekly payments. Making a bi-weekly payment will reduce, and in some cases eliminate the deferred interest all together. Which means your mortgage balance would not increase.
How to set the loan up correctly:
1) The 1% payment option on these loans is only available for the first five years. But you could actually keep one of these loans for 30 or 40 years. If you select a 40 year loan your monthly payment will be lower but the payment options will not last for five years. The name of the game is to keep the 1% payment for as long as possible. So get a 30 year amortization.
2) The 30 year, 15 year and interest only payments are tied to an index. Select a slower moving index like the MTA (Monthly Treasury Average) instead of a faster moving index like the Libor (London Inter-Bank Offered Rate).
So how can you lose with a 1% mortgage loan?
If homes in your area are rapidly going down in value, deferred interest could cause you to become upside down in the home.
But if your area is experiencing a 3% to 5% rate of appreciation and you save what you save by making the minimum payment, a 1% mortgage loan can have an incredibly positive impact on your financial future.
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