Lower Interest Rate is Not Always a Savings in the Long Run
Interest rates are important, but a lower interest rate is not the only thing to consider when choosing a home loan. The lowest interest rate does not always save you the most money or get you the best deal.
There are other factors to consider, including:
- Fees (including points)
- Closing Costs – the fees associated with home-buying, including application fee, attorney fee, admin or processing feeds, title company expenses, etc…
- Loan Terms
All of these factors could come into play when financing or refinancing a home, which is why it’s important to work with a local lender to understand the full financial picture. Jerry Litwaitis, VP of Lending at MMCCU, explains more below.
Example of Paying More Cost to Get a Lower Rate:
- SCENARIO 1: $100,000 @ 2.75% for 15 years = $678.62 per month-Closing Cost are $1,000
- SCENARIO 2: $100,000 @ 2.00% for 15 years = $643.51 per month-Closing costs are $6,500, which may include $2,000 paid in points to lower the interest rate
The difference in the payments is $35.11, but you need to spend $6,500 in closing costs to get the lower rate of 2.00%.The breakeven point is how long it will take you to recoup the closing costs based on the savings you get from getting the lower interest rate ($6,500 divided by $35.11), which is just over 185 months.
So, you will not have enough time to recoup the additional costs you paid to get the lower interest rate (term of mortgage is 180 months and it will take you 185 months to recoup the costs). Thus, in this scenario, it would be better to take the higher interest rate and pay the lower closing costs.
Side notes:
- Most people do not keep their mortgage loans for the entire term (people pay off early, refinance for debt consolidations, home improvements, child education expenses and so on). The average term that most people keep their mortgages is 7 years before a refinance or something else occurs.
- The interest rate is what you will pay in interest on your home loan. The APR is the interest rate plus other feeds and costs associated with home-buying (so this is what you’ll pay on top of the principal loan amount borrowed for your mortgage).
“Another item a member should look at when shopping for a rate, is whether or not they have to pay points to get the lower rate (one point costs one percent of your loan amount, but does not lower the interest rate a full percent, usually only lowers the rate by 1/8 to ¼ percent),” explained Litwaitis. “So it may cost you much more to lower your interest rate a full percent from what the market is offering.”
Bottom line: Choose the mortgage rate that saves you the most money after factoring in fees, closing costs, and loan terms. Speaking with your local mortgage loan professional is the best way to ensure you’re getting the best possible home loan.
“Financial institutions may offer lower rates than us, but their loss in potential interest income over the life of the loan is made up with upfront closing costs,” said Litwaitis.
“At MMCCU, we want our members to make the best financial decisions even if it’s not in the best interest of the credit union,” added President David Murphy. “We will go over all your options, whether with us or with another lender, and let you know what makes the most sense financially for your situation. This is another benefit of working with a local financial institution.”
To learn more, please reach out to our friendly team at MMCCU.