Best and Lowest Interest Rate or Best and Lowest Closing Costs?

Plus NO Lender Fee, NO Closing Costs, No Origination Fee Mortgages. How do they all work?

A common question home mortgage loan shoppers make is to ask: "What's your lowest interest rate?" or "What are your closing costs?"

As a Mortgage Loan Officer for well over 20-years, I am constantly asked the same two main questions. What is your interest rate, or what are your closing costs? The answer isn’t actually very simple. Low interest rate vs low closing costs, and what is best for you depends on many factors.

While both questions seem logical to ask, they do not give the answer most borrowers need to make a proper decision. Borrowers must understand both interest rates and closing costs, and how they interact with each other.  Interest rates are only half the answer to getting the best mortgage deal. It is possible end up with a low rate, or with low or no closing costs, but not necessarily the best deal.

First understand that ALL LENDERS have essentially the exact same real closing costs to provide you a mortgage loan.

This includes appraisal, credit report, state taxes, county recording fees, title company charges, etc.  Banks and mortgage companies also have to pay the same loan officers, underwriters, processors, and back office staff, so they all need to charge origination fees, processing fees, etc.

So if all lenders have essentially the same costs to obtain, process, and close your mortgage loan, how can one lender do it cheaper then the next? 

The answer is they can't. Remember that nothing is ever free. Lenders simply use "reverse points" whenever they claim to offer any sort of no origination, no closing costs, or lower closing cost mortgage. This is also commonly known as lender credits.

Simply put, the lowest rate & the lowest fees do not go hand-in-hand. 

NO LENDER can offer both together. I can give you the lowest interest rates, but it will cost you in higher closing costs. I can give you the lower closing costs, but lenders make it up by charging a higher interest rate. Most lenders quote their best rate in combination with covering all third party fees (appraisal, credit report, title company, state taxes, county recording fees, etc) with 1% origination ("standard" in the example below).

OPTIONS: Interest Rate versus Closing Cost Comparison

Here is an example of Rate vs. Costs on a $200,000 - 30 year fixed loan (Note: Not actual rates)
	Lower Rate	Standard Quote	Low Cost	Total NO Cost
Rate	4.75%	5.0%	5.25%	5.75%
Origination Fee	1%	1%	None	None
Discount Points	1%	None	None	None
Closing Costs	$7167	$5042	$3042	$0.00
Monthly P & I Payment	$1043.29	$1073.64	$1104.41	$1,167.15
10 Years of Interest	$92,352	$95,240	$98,151	$108,037
20 Years of Interest	$155,609	$162,618	$169,718	$188,181
30 Years of Interest	$181,300	$190,232	$199,311	$221,909

Interest Rate and Closing Costs Education

The first thing to understand is that for the most part, all lenders, regardless of them being a bank, broker, or actual mortgage company all do the same thing, have the same rates, and same costs

For example, FHA guidelines are FHA guidelines no matter who you get your loan from.  If your situation puts you on the far fringe of a programs guidelines, you may run into lenders have have an individual company risk overlay, but I am speaking about the vast majority of loan applicants. 

We all get our base interest rates based on the same mortgage backed security bond market. If my rates go up, so do theirs.  If my rates go down, so do theirs. Lenders don’t just make up rates. Today’s bond market plus our margin equal today's rates

We all have the same REAL closing costs, most of which are not actually the lenders costs. Appraisal, credit report, title company, state deed taxes, county recording fees, and initial pre-paid items of taxes and insurance are all the same, or so close as to not make a difference no matter who you deal with.

We all also don’t work for free. Anyone claiming they don’t charge a normal cost, no lender fees, or things like free appraisal are making up up somewhere else.

Interest rates can vary based on many items, including loan program, credit score, state, property type, and down payment size. because of this, my opinion is most instant online interest rate quotes are worthless. 

Different Interest Rate Quote Techniques

Differences in standard quoting techniques are everywhere, and super confusion to most home buyers. There are four main interest rate and closing cost options. Understanding all four makes you a better shopper.

STANDARD RATE QUOTE:

The traditional mortgage loan interest rate quote is based on today’s lowest rate for your situation, combined with you paying all standard and traditional closing costs. There are no discounted cost, no free appraisals, and no discount points to artificially buy down the rate. This is the most commonly quoted option.

NO LOAN ORIGINATION FEE QUOTE

The mortgage loan interest rate quote is based on today’s lowest rate for your situation, combined with you paying all standard and traditional closing costs, EXCEPT the lender does not charge you the standard 1% loan origination fee. Sounds great, but no lender works for free. The no loan origination is achieved by increasing your loans interest rate by typically 0.25%. The actual amount will vary based on program and loan size. This is the second most popular interest rate quote.

LOW RATE WITH DISCOUNT POINTS QUOTE

This option is based on today’s base rate for your situation, combined with you paying all standard and traditional closing costs, PLUS additional closing costs known as discount points to buy down your interest rate. For example, maybe you pay an additional 1% of the purchase price in closing costs today, and this may get you and interest rate 0.25% lower. The amount of points you pay, and the actual rate change will vary based on program and loan size. This option is highly quoted on internet rate quote comparison sites.

NO CLOSING COST QUOTE

The mortgage loan interest rate quote is based on today’s base rate for your situation, but where you typically do not pay any loan closing costs, except for any initial escrow account set-up costs, like pro-rated property taxes and insurance. Again, there is no such thing as no costs, they just hide the costs in a higher interest rate. The actual increase in the interest rate will vary based on loan size, and dollar amount of real costs the lender needs to bury into the interest rate. It is not uncommon to see interest rates 0.50% to 0.75% about the standard quote rate.

HOW TO SHOP INTEREST RATE OFFERS?

Most people call and ask “What is your interest rate.” A good question, but based on the various quoting techniques, can leave you with confusing answers for comparison purposes.

I usually advise people to PICK on of the offer options, then when contacting lenders, be sure to tell each lender you desire the same type of quote. Standard offer vs Standard offer, or no origination versus no origination.

Another good tool is to ask based on a hard closing costs number. Ask everyone for a quote based on closing costs being $7,000 for example. Then the only difference is interest rate.

More information on How to Shop Interest Rates

BEWARE OF LOW QUOTING TRICKS

Since the real estate collapse in 2007, rules and regulations have been improved dramatically, but there are still common tricks. The current biggest being under quoting pre-paid items of taxes and insurance.

I recently quoted a client estimated home owners insurance of $1,400 for the year. The competition quoted $700 for the year. Needless to say, the client was thrilled with the $700 cheaper quote, and wanted to go with the competitor.

I informed the client that this was just our guessing, and that whatever his insurance policy premium actually cost, would simply be passed on and adjusted in his final numbers.

I also informed him that while a guess, we are supposed to be as accurate as possible, and that maybe he should hand up and call his insurance agent.

His actual quote was $1290. So I was a little high, but the competition was way off low.

Low interest rate vs low closing costs. What is best?

There is no correct answer, and one is not better than another. Your answer lies in your individual situation.

If you are a first time home buyer who can barely come up with your down payment, you may opt for the no loan origination fee, or the no closing cost loan. Yes, your interest rate and payment will be higher, but if you don’t have the money, this may be a good option.

The next person may be selling their small first home, and buying their bigger forever home. They may also be netting a nice profit. Therefore not only do they have plenty of money for down payment and closing costs, they may also have plenty to buy the interest rate down – which saves them a lot of money over the long haul. 

WHICH LOAN VERSION is RIGHT FOR YOU?
I can offer you all four options on all most of our mortgage loan programs.

The combination of rate & fees can be very confusing. One lender is screaming "No closing costs." A second lender may quote you 3.75% with $2246 in fees, while another lender is offering 3.50% with $4130 in fees. So are closing costs and fees bad? Well if you ask everyone's brother who has a real estate license and knows everything about mortgages, then the answer you will most likely hear is yes.  I am here to tell you everyone's brother is probably wrong.

Good enough answer?  I don't think so...

Begin by asking yourself "How long am I going to be in this loan or property?" This is the single most important question to determine most of your rate versus cost choices.  Review the chart above again, It becomes very obvious based on how loan you are going to be in the home if the Best Interest Rate or the Lowest Closing Cost makes the most sense for you and your family.

Congratulations, you are now smarter that everyone's brother, mother, father, sister, friend, or co-worker with a Real Estate License.