Picking The Right Rate – Lowest Is Not Always Best
Often times requesting the lowest rate from your lender can actually cost you thousands of dollars in unnecessary fees. Consumers have been conditioned to believe that “lowest = best” but that’s rarely the case. I prepared calculations for a client this week who wanted 3.75% because she had seen that advertised on the internet. The 3.75% is certainly available, but the costs associated with that rate were such that it was going to be 12 years before she broke even on that deal.
While the rate trend chart published with this article indicates just one average rate, there are actually 10 different note rates to choose from on my rate sheet for a 30 year mortgage. The highest rate is 4.625% and the lowest is 3.5%. Mortgage note rates are typically priced in 1/8th percent increments so there is a linear payment difference between each choice. For example, if there is a $12 per month payment difference between 4.125% and 4% then there will be an equal $12 payment difference when you move down another 1/8th to 3.875%.
If your mortgage payment is lower as the rate goes lower, it would make sense to take the lowest rate available, right? The reason that might be wrong is because you have to consider the amount of fees you will have to pay to get that note rate. The lower the rate the higher the upfront costs. And the costs increase exponentially after the interest rate reaches the most efficient cost point. And that efficient point is different for every borrower.
Unlike the linear payment difference between the note rates, there is an unequal difference in cost. Looking at my rate sheet today there is a .544% cost difference between 4.125% and 3.99% but it increases to .590% when you go down to 3.875% and then a huge jump to 1.082% in cost if you move down to 3.75%. Using a $200,000 loan as an example, that means the upfront cost for the 3.875% note rate is $2,164 more than for the 4.125% note rate, and all for a savings of $29 per month. In this example you’d have to keep this loan for more than 6 years just to break even on the upfront investment.
And therein lays the mistake most lenders make when “selling” a rate to you. When you call and ask a lender “what’s your best rate?,” or “what’s your lowest rate?” they will cheerily give you the answer they think you want to hear. But very few will say “why do you want the lowest rate? Are you sure you won’t refinance this loan or sell the home within the next 6-8 years?”
The “best” rate for you is the one that best meets your needs from an affordability standpoint while not costing so much money upfront that you waste all that investment if you refinance or sell the home within the next 6-8 years. In many cases it might even make sense for you to go up in the rate such that the lender is providing a credit towards your closing costs. With FHA loans we often process what is called a Streamline Refinance and all of the closing costs are covered by a lender credit. In that scenario your breakeven point is almost immediate because you’ve just lowered your payment $75 or $100 per month with no costs whatsoever.
Getting the right interest rate is not something you can just pick based upon what the lender sells you or by requesting the lowest option. You need to ask your lender to give you 2-3 different note rate options and have them show you the different breakeven points. Only then can you be assured of making a smart choice.
Michael has 21 years’ experience in the lending industry. In that time he’s directly helped over 1,400 families finance the purchase of a new home or refinance an existing loan. Rebecca has a CPA background in auditing financial institutions which brings an incredible resource to First Priority Financial. They are licensed to help families in the states of WA and CA. If you, or anyone you know, needs help with a home loan call 509-252-9151 or send an email to Mike Mullin