There is more to a mortgage rate than meets the eye. I have many buyers ask me about rates, and I do my best to track them and meet with lenders regularly to keep an eye on the market.
If you have excellent credit, your mortgage rate can be what you want it to be, within reason. Any buyer has the option to “buy down” their mortgage interest rate—that is, to lower it by buying “points” to get a credit on the rate, which gives you a lower monthly mortgage payment.
Buying down your rate can be vastly different from lender to lender. Know that nothing is free—when a company teases you with big-bang ads about rates that seem much lower than your bank’s (online companies are really good at this), they will charge points, or extra fees paid at closing, to offer those low rates. Many times online lenders are not up front in disclosing that.
Here are some important things to consider:
There is no set interest rate reduction formula—it depends on the lender and the marketplace.
Buying down your rate may give you a tax benefit. Contact a tax professional to see whether doing so might affect your tax situation. (I am a firm believer in not doing something just for a tax benefit, but if it fits the big picture and a benefit is to be had, definitely research whether you can take advantage of it!).
Points for adjustable-rate mortgages (ARMs) typically provide a discount on the loan’s interest rate only during the initial fixed-rate period. What this means is that your ARM is fixed for three, five, seven, or 10 years and after that it adjusts to a different rate for the remainder of the term of the loan. If your break-even point occurs well before the fixed-rate term expires, it makes more sense to consider. With some major banks, if rates go up during the adjustable period, your rate should still be lower based on the points you initially purchased.
If you need to decide between making a 20 percent down payment and buying points, make sure you run the numbers. You’ll need to know your lender’s cost per point, as well as the base annual percentage rate (APR) at zero, one, and two points. Take the principal amount that you will borrow and calculate the monthly principal and interest payment for each option. Add up the mortgage cost savings for one and two points compared to the payment in the zero-point column. To calculate the time needed to recover the cost of paying the point, take the total fee for the point reduction and divide it by the monthly mortgage savings amount. That will give you the number of months it will take to absorb the cost.
If your down payment is less than 20 percent, you may be required to carry private mortgage insurance, or PMI, depending on the type of loan you are getting. PMI is for the sole benefit of the bank if you default on your payments; it does not protect you if you stop making payments. If you have to pay PMI, your lender can help you calculate the cost to see if it is worth taking that option.
Paying down your mortgage rate may make sense if you are selecting a fixed-rate mortgage and you plan on being in the home after you reach the cost-recovery point. While no one can predict the future, it could be worth it if you plan on staying in your home for 10 years. If you think you will be there only three to five years, it may not be. If not, don’t sweat it. You may have friends who like to talk about how low their rates are, but you’ll be armed with additional information. Their low rate must have fit their situation, but yours, at half a point higher, may fit your situation best. Avoid rate envy!
With regard to refinancing, always remember three things: Calculate your break-even or cost-recovery point with the new rate. Remember that when you refinance a loan, you are starting the loan term over again. And be aware that you will have closing costs just as you do when purchasing a home. The lender will require title insurance, an appraisal, and the like, just as with a home purchase, so you need to have cash on hand for closing fees and calculate those into your formula (or those costs will be added into the new loan, resulting in a higher payment). Sometimes a refinance doesn’t make financial sense. A good lender will walk you through your financial picture and tell you as much.
It’s best to talk with a local lender who has experience in the marketplace and not someone who just offers loans online. Your financial security and future are too important to be swayed by the newest online lender’s flashy low rate in a TV ad.