Kicking the tires on residential mortgages
With residential mortgage interest rates near record lows, people are looking at the possibility of refinancing their homes. Real estate is the biggest
investment many of us make, and, like any investment, it requires our careful attention and management.
In buying an automobile, there’s more to consider than simply kicking the tires. The same is true when looking at mortgage interest rates.
There is an old rule of thumb on interest rates that goes something like, “When there’s at least a two-point spread between the rate you have and the rate
you can get, then it’s time to look at refinancing.” Unfortunately, when interest rates fall as low as they are now, this advice might not apply. Instead of a
two-point spread, even a one-point spread might represent a call to action.
So how do you comparison-shop mortgage rates-especially when they are cluttered up with application fees, interest rate buy-down points, and other charges?
It’s easier than one might think at first glance.
The first step is to be very clear about your own plans. Are you going to live in the home? Short-term or long-term? When you’ve answered these
questions, you’re ready to move on.
The second step is to search the field for advertised interest rates-call local institutions, look on the Internet, watch the newspapers. This is the
information collection step. Make no decisions based on advertised rates alone-you must dig deeper.
The third step can be combined with the second. Here you want to get all the players on the same playing field, namely, your own, not theirs. Ask each
lender for their best rate for the type of mortgage you’re comfortable with (30-year fixed, 15-year variable, etc.) and be prepared for numbers all over the
map. They should be happy to give you the monthly mortgage payment you can expect-insist that they separate out all taxes and insurances because you’re
interested only in principal and interest here. In almost every case, they will have upfront fees (application fees, buy-down points, etc.) which you should
carefully list separately-and dig into.
The fourth step you do alone. Only when you have all the information in hand from several lenders, can you comparison-shop your mortgage.
You should have in front of you each lender’s projected monthly payment for principal and interest on, for example, a 30-year fixed rate mortgage. But
you’re not finished. Now, you must add back to each one any application fees, buy-down points required upfront, etc. Keep in mind that application fees are
frequently negotiable-especially in today’s competitive market. So are buy-down points (these are the points you pay up-front to get a lower interest rate-a
“point” is equal to one percent of the total amount to be mortgaged, e.g., $1,000 on $100,000).
If you did not discuss all this in your initial conversation, then call each lender back, focusing on up-front points (or buy-down points). If they’ve
quoted one point up-front, ask what it (the monthly mortgage payment) will be with no points up-front. If they’ve quoted with no point, ask what it will be if
you pay a point or two up-front. Unless you are especially adept at doing this in your head, you’ll need to take extensive notes in order to make your
The fifth step is decision time. You should have enough information now to compare apples with apples. Here, you want to add to your projected monthly
mortgage payment (principal and interest only) the cost to you of those up-front points. Take the difference between the “no points” figure and the “up-front
points” figure each has offered, divide it by the total dollars they want up-front, and-presto!-you’ll get the number of months it will take you to recoup the
up-front points (in dollars).
Here’s a detailed example. Let’s say your 30-year fixed rate mortgage is for $300,000. A lender offers you a 7.25% mortgage with no up-front points, which
results in a monthly payment of about $2046. If you will pay a point up-front (in this case, one point is $3,000), the rate offered will be 7.0%, or about
$1,996 per month. The difference is about $50. Divide this into $3,000 and you get 60 months or 5 years to recoup the cost of that up-front point. Now,
remember that you have 25 years to go on the mortgage. If you keep it to term, you’ll be saving $15,000 (25 of the 30 years are left x 12 months per year x $50
per month = $15,000).
Once you understand how to kick the tires on the different programs available, you can go shopping for your mortgage with new-found confidence. You might
use this mechanism to negotiate even higher up-front points in order to lock in more attractive long-term rates-it all depends on your particular situation.
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