Everyone wants to get the lowest mortgage rate they can when
buying a home or refinancing their current home loan. But chasing
after the lowest rate can be a sucker's game.
That's because the lowest interest rate doesn't necessarily mean
the least expensive loan. And when it comes right down to it, what
you're really looking to do is save money, right?
The problem is that the interest rate is only part of what
determines how much you'll pay for your mortgage. It may be the
biggest and most obvious part, but there are other things you need
to consider as well. And those can have a significant impact on the
overall cost of your mortgage.
Low rates can mean high fees
Some lenders will advertise a low interest rate, but charge
higher up-front fees and closing costs to make up for it. These can
add up to thousands of dollars and in some cases may even be double
what a different lender would charge.
Borrowers may realize that one lender charges higher closing
fees than others do, but shrug it off and figure they'll get it
back on the lower interest rate. After all, those small savings add
up and the power of reverse compounding means you'll pay down your
principle faster and save money over the long run, right?
Well, yes and no. A smaller interest rate does mean that you'll
pay down your principle more quickly, but those additional fees
mean you'll have more principle to pay off to begin with (assuming
you roll your closing costs into the loan). Often, you'll find that
a loan with a low interest rate but high up-front fees will cost
you more over the long run that a mortgage with a rate that runs a
quarter of a percent higher but has lower fees. Lenders know their
math - they're going to offer a deal that leaves them holding the
short end of the stick.
Should you buy points?
Often, lenders will advertise a low mortgage interest rate that
is based on charging points. Discount points are another type of
up-front fee that are separate from what the lender charges for
originating the mortgage. They're actually a type of pre-paid
interest that enables you to lower your interest rate by paying a
certain amount up front.
Each discount point costs 1 percent of the amount borrowed and
typically lowers your interest rate by one-eighth of a percentage
point. So if you're borrowing $200,000, one point would cost $2,000
up front and might give you an interest rate of 3.87 percent
instead of 4.0 percent on a 30-year, fixed-rate mortgage. Two
points would cost $4,000 and might enable you to get the rate down
to 3.75 percent.
It typically takes about 8-10 years for the savings on interest
to equal the upfront cost of discount points on a 30-year mortgage.
So the question of whether you should pay for discount points or
not largely depends on how long you're going to stay in the
Using APR as a guide
The best way to figure out how much a mortgage is actually going
to cost you is to use a mortgage calculator and figure out how the
costs of two different loans will play out over time. That's not
always easy to do, so a simplified way of comparing two loans is to
simply look at the annual percentage rate, or APR for the loan.
The APR is a way of expressing the total cost of a mortgage in
terms of an interest rate. Basically, it's the rate you would pay
if you took all the additional costs of the loan and rolled them
into the interest rate. The APR is a handy rule-of-thumb for
comparing different loan offers, but it's not an infallible guide,
so it's best to calculate the actual costs of competing loan offers