Choosing a Mortgage Loan is a big decision

The good news is you have many mortgage options. That's also the bad news. 

Picking a mortgage is one of the biggest financial decisions an individual or family makes, so it's crucial to see how your choices affect your total financial picture. Too many borrowers shop just for the lowest rate. The Internet has further turned mortgages into a commodity. The lowest rate on the wrong program is far more costly than a competitive rate on the program that best suits your needs. 

Rates are important, but you also need to consider a host of other variables, including taxes, term, fixed vs. adjustable, rate locks, and perhaps most importantly, the loan amount. 

The size of the loan is perhaps the most frequently neglected question. Buyers commonly shy away from larger mortgages because they mistakenly don't understand the alternative uses of their money. Most people fear debt, sometimes to a fault.

Homebuyers often have better alternatives for their money than putting it toward the purchase of a house merely to cut the size of their mortgage. For example, many relatively safe tax-exempt bond funds can pay a better after-tax return than you would get from paying down your mortgage.

A family in the 28% tax bracket actually earns 9.44% after taxes are figured on a municipal fund paying 6.8%. So at mortgage rates below 9.44%, you should take out the biggest mortgage possible.

Home prices have escalated in recent years. Many homeowners find themselves with small mortgages relative to the market value of their homes.

An example helps bring the point home:

You buy a home valued at $250,000. You put $150,000 down. That leaves you with a $100,000 mortgage at say 7.5%. You could also put $50,000 down and take out a $200,000 mortgage. You could then take that $100,000 of free cash and put it into a municipal bond fund yielding 6.8% -- you'll probably end up making more in the long run.

Look at it this way; the $100,000 borrowed would cost 7.5% minus the tax deduction (let's say 28%) of 2.1%, netting the cost out to 5.4%. The difference between the two options (6.8% municipal bond and 5.4% net cost on the mortgage) is 1.4%. The savings on $100,000 would be $1,400 per year. The higher the tax bracket the greater the savings.

Be careful not to borrow more than 80% of the value of your home or you will probably need to pay an extra mortgage insurance fee. This fee would negate the savings. The mortgage tax deduction ends at $1,000,000 for first mortgage liens on primary residencies. The deduction for second liens is capped at $100,000. Mortgage rates can be slightly higher for loans over $333,700. This is the new limit for "jumbo" loan amounts.

I see so many people using a refinance to save money by lowering their monthly payment and that's great. But the monthly savings is often spent frivolously and not used for a long term, meaningful investment like college or retirement. Think about keeping your payments the same but borrowing the higher amount. So if you owe $200,000 and are saving $200 monthly by refinancing, you could borrow $230,000 and keep the same payment. That $30,000 could be used to invest for your child's college education. Based upon historic rates of return for the S&P 500, that $30,000 investment would be worth $240,000 in 15 years. That’s a great way to save for college.

A mortgage is typically the largest single financial move people make and should be the centerpiece of any good financial plan. Use it to create wealth for yourself. Lets say you wanted a loan of $200,000 on a home worth $350,000. If you borrow an extra $50,000 you can invest that money. At historic rates of return of 15% annually, that investment would be worth around $400,000 in 15-years. That's enough to pay off the mortgage completely in half the time and give yourself a bonus of $215,000 in addition. Now that's a nice way to help your retirement plans.

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