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I_____________________________________________________________ NTRODUCTION In this chapter, I’ll discuss how to use the income from a small, parttime, home-based business to pay off a mortgage several years sooner and keep many thousands of dollars in our pockets rather than giving them to the mortgage company. _____________________________________________________________
Definition
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A mortgage loan is a loan secured by real property through the use of a mortgage note which evidences the existence of the loan and the encumbrance of that realty through the granting of a mortgage which secures the loan. However, the word mortgage alone, in everyday usage, is most often used to mean mortgage loan.
A home buyer or builder can obtain financing (a loan) either to purchase or secure against the property from a financial institution, such as a bank or credit union, either directly or indirectly through intermediaries. Features of mortgage loans such as the size of the loan, maturity of the loan, interest rate, method of paying off the loan, and other characteristics can vary considerably.60
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The word mortgage is a French Law term meaning "death contract", meaning that the pledge ends (dies) when either the obligation is fulfilled or the property is taken through foreclosure.
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Types Of Mortgage Loans
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There are many types of mortgages used worldwide, but several factors broadly define the characteristics of the mortgage. All of these may be subject to local regulation and legal requirements. • interest: Interest may be fixed for the life of the loan or variable, and change at certain pre-defined periods to higher or lower rates. • term: Mortgage loans generally have a maximum term, that is, the number of years after which an amortizing loan will be repaid. Some mortgage loans may have no amortization, or require full repayment of any remaining balance at a certain date, or even negative amortization. • payment amount and frequency: The amount paid per period and the frequency of payments; in some cases, the amount paid per period may change or the borrower may have the option to increase or decrease the amount paid. • prepayment: Some types of mortgages may limit or restrict prepayment of all or a portion of the loan, or require payment of a penalty to the lender for prepayment.
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The two basic types of amortized loans are the fixed rate mortgage (FRM) and adjustable-rate mortgage (ARM) (also known as a floating rate or variable rate mortgage). In some countries, such as the United States, fixed rate mortgages are the norm, but floating rate mortgages are relatively common. Combinations of fixed and floating rate mortgages are also common, whereby a mortgage loan will have a fixed rate for some period, for example the first five years, and vary after the end of that period. _____________________________________________________________ Profitable Planning & Management Inc. Page 84
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• In a fixed rate mortgage, the interest rate, and hence periodic payment, remains fixed for the life (or term) of the loan. Therefore the payment is fixed, although ancillary costs (such as property taxes and insurance) can and do change. For a fixed rate mortgage, payments for principal and interest should not change over the life of the loan, • In an adjustable rate mortgage, the interest rate is generally fixed for a period of time, after which it will periodically (for example, annually or monthly) adjust up or down to some market index. Adjustable rates transfer part of the interest rate risk from the lender to the borrower, and thus are widely used where fixed rate funding is difficult to obtain or prohibitively expensive. Since the risk is transferred to the borrower, the initial interest rate may be, for example, 0.5% to 2% lower than the average 30-year fixed rate; the size of the price differential will be related to debt market conditions, including the yield curve. The charge to the borrower depends upon the credit risk in addition to the interest rate risk. The mortgage origination and underwriting process involves checking credit scores, debt-to-income, down payments, and assets. Jumbo mortgages and subprime lending are not supported by government guarantees and face higher interest rates.61 _____________________________________________________________
Applying For A Mortgage
In the United States it is most common for borrowers to apply for mortgages online. There are several industry leaders including www.lendingtree.com who specializes in mortgage loans and match you with lenders while
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www.bankrate.com provides a similar service but also offers several other loans. Other sites such as www.onereversemortgage.com cater to a generation approaching retirement while sites like www.lendasaurus.com provide a service to anonymously monitor loan pre-approvals. Additional sites by direct lenders from individual loan officers to companies such as Quicken allow borrowers to apply online. Most mortgage lenders are not local to their customers and possess licenses in many states which has made the internet and technology invaluable for lenders while allowing borrowers to compare rates. Many times, even when a borrower applies for a mortgage in person the application is submitted online and the borrower can follow their loan application status online. 62 _____________________________________________________________
Loan To Value & Down Payments
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Upon making a mortgage loan for the purchase of a property, lenders usually require that the borrower make a downpayment; that is, contribute a portion of the cost of the property. This downpayment may be expressed as a portion of the value of the property (see below for a definition of this term). The loan to value ratio (or LTV) is the size of the loan against the value of the property. Therefore, a mortgage loan in which the purchaser has made a downpayment of 20% has a loan to value ratio of 80%. For loans made against properties that the borrower already owns, the loan to value
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ratio will be imputed against the estimated value of the property.63 _____________________________________________________________
Value: Appraised, Estimated, Actual
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Since the value of the property is an important factor in understanding the risk of the loan, determining the value is a key factor in mortgage lending. The value may be determined in various ways, but the most common are: • Actual or transaction value: this is usually taken to be the purchase price of the property. If the property is not being purchased at the time of borrowing, this information may not be available. • Appraised or surveyed value: in most jurisdictions, some form of appraisal of the value by a licensed professional is common. There is often a requirement for the lender to obtain an official appraisal. • Estimated value: lenders or other parties may use their own internal estimates, particularly in jurisdictions where no official appraisal procedure exists, but also in some other circumstances.64 _____________________________________________________________
Whether you’re buying a $500,000 house, a $100,000 house or a house of any other value, a part-time, home-based business can help you pay off your mortgage several years early thus saving many thousands of dollars that you can use for university expenses for your children, retirement savings for yourself, or whatever other financial goals you might have.
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P AYING DOWN YOUR MORTGAGE _____________________________________________________________
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After the first two years of operating your new business, assuming you can pay an extra $500 per month against your mortgage, you can pay off your mortgage 5 to 13 years early and save thousands of dollars.65
The savings can be substantial! _____________________________________________________________
Example: $500,000 Mortgage
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For a $500,000 mortgage at 6% for 25 years, the monthly payments are $3,221.51 and the total of all payments is $966,451.
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If you can’t set up a Line of Credit as discussed in Chapter 8, “Line of Credit”, hold back $14,000 from your downpayment. Use the $14,000 to set up your home-based business. Then, the monthly payments on a $514,000 mortgage will be $3,312. That’s an extra $90 per month ($3 per day). At the end of the second year, use your new income from the your home-based business to increase your monthly payments by $500. Monthly payments are now $3,812 for 17.6 years ($3,312 from your pocket, $500 from your home-based business). You’re done paying after 19.6 years vs 25 years. Your total expense is $3,312 from your pocket x 12 months x 19.6 years = $778,982.
Keep $187,461 in your pocket. ($966,451 minus $778,982)
Of course, if your business is producing more than $500 per month, you can increase your mortgage payments, pay off the mortgage faster and save even more money. _____________________________________________________________ Profitable Planning & Management Inc. Page 89
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In this hypothetical scenario, during the 17.6 years that you used the $500 per month from your home-based business to increase your mortgage payments, your part-time, home-based business paid off $105,600 of the debt.
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Example: $200,000 Mortgage
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For a $200,000 mortgage at 6% for 25 years, the monthly payments are $1,288.60 and the total of all payments is $386,580.
If you can’t set up a Line of Credit as discussed in Chapter 8, “Line of Credit”, hold back $14,000 from your downpayment. Use that $14,000 for your home-based business. Then, the monthly payments on a $214,000 mortgage will be $1,379. That’s an extra $90 per month ($3 per day). At the end of the second year, use your new income from your home-based business to increase your monthly payments by $500. Monthly payments are now $1,879 for 13.3 years ($1,379 from your pocket, $500 from your home-based business).
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You’re done paying after 15.3 years vs 25 years. Your total expenditure is $1,379 from your pocket x 12 months x 15.3 years = $253,184.
Keep $133,432 in your pocket. ($386,580 minus $253,148)
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In this hypothetical scenario, during the 13.3 years that you used the $500 per month from your home-based business to increase your mortgage payments, your part-time, home-based business paid off $79,800 of the debt.
Of course, if your business is producing more than $500 per month, you can increase your mortgage payments, pay off the mortgage faster and save even more money. _____________________________________________________________
C ONVERT MORTGAGE PAYMENTS TO SAVINGS _____________________________________________________________
In the $500,000 mortgage example, continuing to save $3,312 from your pocket and $500 from your home-based business would result in you having put $251,592 into your savings account during the remaining 5.5 years. With interest or return on investment calculated, you could have the following amounts in your savings or investment account:
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After the mortgage is paid off, continue making the monthly payments into a savings plan, including the $500 from your homebased business. The money available at the end of the original 25year period can be significant.
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• $314,742 at 8% (see Appendix A), • $297,202 at 6%, or • $273,168 at 3%. In the $200,000 mortgage example, continuing to save $1,379 from your pocket and $500 from your home-based business would result in you having put $218,715 into your savings account during the remaining 9.7 years. With interest or return on investment calculated, you could have the following amounts in your savings or investment account: • $328,968 at 8%, • $295,762 at 6%, or • $253,498 at 3%. Do the above numbers make it worthwhile to add $3 per day to your mortgage payments? Of course, if your business is producing more than $500 per month, you can increase your monthly savings and have even more money than indicated above. Participating in a successful part-time, home-based business could be very lucrative for you and your loved ones.
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S UMMARY _____________________________________________________________ As shown in the previous two examples, you can save tens of thousands of dollars on your mortgage by adding $3 per day to your monthly mortgage payments and using the revenue from your homebased business to further increase your monthly payments after the first two years.
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The savings over the years remaining between the end of mortgage payments and the initial 25-year term can be used for university expenses, put into retirement savings, or simply used to improve your everyday lifestyle.
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