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 home.
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 when possible.