HOW THE BEST INTEREST RATES WORK
In many cases, you have the option to pay more money upfront in exchange for a lower rate. Some refer to this as “paying points,” buts that’s a bit of an archaic term. Self-annointed gurus used to say “never pay points!” But that’s not necessarily good advice. Discount (or “discount points”) offers a perfectly legitimate and objective choice to pay more money upfront in exchange for a lower interest rate. Whether or not the trade-off makes sense to you is fairly subjective.
In the more intelligent conversations, discount is discussed in terms of “breaking even” or “break even months.” In other words, if I pay extra cash today, how long will it take for me to break even due to lower monthly payments. Closer to 10 years? That doesn’t make sense for most people. 5 year or less, however, and it can start to make better sense.
All this to say that the discount points required to move down to 1/8% are fairly low for most lenders at the moment. For instance, paying an extra .5% of the loan amount could get you another eighth of a point lower interest rate, and it would take just over 4 years to break even on that extra expense. Of course, if you plan to sell or refinance in 3-5 years, this makes no sense. If this is the last house and mortgage you want for the foreseeable future, it’s something to consider.
HOW THE LOWEST CLOSING COSTS WORK
A similar conversation can be had for paying less in closing costs up-front today. You can choose to pay lower closing costs today, but understand this is simply achieved by the lender raising the interest rate you would get. Small reduction in costs equal small rate increases, while large reduction in closing costs equal large interest rate increases.
This trade off is know as ‘Lender Credits’
So again, what is the math, and does it make sense? A common lower closing cost quote is a “No Loan Origination” quote. On most fixed-rate loans, you can eliminate loan origination costs, which is 1% of the loan amount by roughly increasing the interest rate 1/4%.
On a $200,000 loan, eliminating loan origination would save you $2,000 today, but a 1/4% higher interest rate will cost you $29 more per month on that $200,000 loan. Simple math gives you a 69 month break even period. If you are in the loan less than 69 months, you win. Each month after 69, you pay an additional $29.
What is the math calculation on your loan amount?
But wait, even this is too simple. Do you have the money today? Do you want to keep some of that money in your pocket today to use for something else? So again, Whether or not the trade-off makes sense to you is fairly subjective.
Lower closing costs in exchange for higher interest rates is also a perfectly legitimate tool for home owners.
THE BOTTOM LINE
Don’t fall for advertising gimmicks. Rates way lower than everyone else, you are buying discount points, but may not know it. Anyone offering ‘no lender fees’, rebates, or any other sort of reduced closing costs are simply increasing the interest rate to pay for it.
The bottom line is simply this. A good conversation with a licensed, experienced, professional Loan Officer over your long-term, short-term, payment and equity objectives, is the only way to determine what is best interest rate for you and your situation.