When qualifying for a mortgage, of primary concern is your interest rate. The lower your interest rate, the lower your monthly payment and, ultimately, the lower the total cost of your home over time.
For example:
On a $100,000 30 year mortgage, with a 5% interest rate, you will pay $536.82 per month.
On the same loan with a 6% interest rate, you will pay $599.55 per month.
On a $100,000 30 year mortgage, with a 5% interest rate, you will pay a total of $93,255 in interest.
On the same loan with a 6% interest rate, you will pay a total of $115,838 in interest.
Some lenders offer discount points. They allow you to “buy down” your interest rate. What this means is that you can buy, from the lender, a lower interest rate. You are actually paying the lender the interest today rather than over time. Prepaying your interest will give you a lower monthly payment but it means more money out of your pocket up front.
Discount points typically cost 1% of the total amount of the loan. Each point lowers your interest rate by one-eighth to one-quarter of your interest rate. For example, on a $100,000 loan, each point is $1,000. If your interest rate is 6% and each point lowers your interest rate by one-quarter or 0.25%, 2 points will cost $2000 and your interest rate will then be 5.5%. The lower you want your rate, the more points you’ll be charged up front.
Warning – buying down your interest rate is an advantage only if you plan to stay in the home long enough to save enough from your monthly payments to cover the cost of prepaying your interest. Lenders are anxious to sell you a lower interest rate because they get their cash immediately rather than waiting for it from your interest payments over time.
Depending upon your credit score and the bank’s standard procedures, you may be quoted an interest rate that sounds something like, “prime plus two points”. This means that your loan interest rate is 2% higher than the prime rate of lending at the time of your loan application. If the prime rate that day is 5%, your mortgage rate will be prime plus 2 points (2%), or 7%.
Some banks charge an up-front fee for the loan expressed in points. If your loan was $100,000 and your bank charged 3 points for the loan, the fee amount would be $3,000. Know what your lender charges.
There is much to pay attention to when shopping for loans. Lenders who charge no closing costs and/or no points typically have higher fees but you pay less up front. It may benefit you to pay some of these fees in your loan if you have less money saved for a down payment.
Again, different lenders have different processes and different fees. Always shop around for the best rates and lowest fees. And remember, the banks make their money by lending so they want your business and will negotiate some of these charges to get it.
What’s been your experience? What can you add to the discussion?
